It has become a campaign ritual. Immediately after the release of unemployment figures on the first Friday of every month, Democratic and Republican spin shifts into high gear.

“Our mission is not just to get back to where we were before the crisis. We’ve got to deal with what’s been happening over the last decade, the last 15 years — manufacturing leaving our shores, incomes flat-lining — all those things are what we’ve got to struggle and fight for,” Obama declared at the Dobbins School in Poland, Ohio.

Romney took the opposite tack in Wolfeboro, N.H.: “This is a time for America to choose whether they want more of the same; whether unemployment above 8 percent month after month after month is satisfactory or not. It doesn’t have to be this way. America can do better and this kick in the gut has got to end.”

Both candidates are only tinkering at the edges of the most important issue facing the United States: the hollowing out of the employment marketplace, the disappearance of mid-level jobs.

The issue of the disappearing middle is not new, but credible economists have added a more threatening twist to the argument: the possibility that a well-functioning, efficient modern market economy, driven by exponential growth in the rate of technological innovation, can simultaneously produce economic growth and eliminate millions of middle-class jobs.

Michael Spence, a professor at N.Y.U.’s Stern School of Business, and David Autor, an economist at M.I.T., have argued that this “hollowing out” process is a result of twin upheavals: globalization and the hyper-acceleration of technological progress.

Just two weeks ago at the Aspen Ideas Festival, Alan Krueger, Chairman of the Council of Economic Advisers, stressed this theme:

If you look at the decade before the recession, the U.S. economy was not creating enough jobs, particularly not enough middle class jobs, and we were losing manufacturing jobs at an alarming rate even before the recession. And I would also put together, combined with those two problems, the polarization of the U.S. job market, the fact that we are getting more and more people at the very top and the very bottom and the middle has been shrinking.

In recent months, Erik Brynjolfsson, a professor at the M.I.T. Sloan School of Management, and Andrew McAfee, a research scientist at M.I.T.’s Center for Digital Business, have raised the stakes in this discussion with the publication of “Race Against the Machine” and a collection of accompanying essays and papers by the authors.

McAfee has graphically illustrated the key findings that worry him and Brynjolfsson. The red line in the figure below, the employment to population ratio, tracks the ratio of the number of people working to the total number of working-age men and women in the United States.

CLICK TO ENLARGEOn his blog, McAfee explains the graphic:

Since the Great Recession officially ended in June of 2009 G.D.P., equipment investment, and total corporate profits have rebounded, and are now at their all-time highs. The employment ratio, meanwhile, has only shrunk and is now at its lowest level since the early 1980s when women had not yet entered the workforce in significant numbers. So current labor force woes are not because the economy isn’t growing, and they’re not because companies aren’t making money or spending money on equipment. They’re because these trends have become increasingly decoupled from hiring — from needing more human workers. As computers race ahead, acquiring more and more skills in pattern matching, communication, perception, and so on, I expect that this decoupling will continue, and maybe even accelerate.

This view is controversial — especially McAfee’s argument that the decoupling of jobs from other positive economic developments “will continue, and maybe even accelerate.” In other words, the downward employment and jobs spiral will keep going, driven by structural forces. Policies to ameliorate the process – a shorter work week, a massive investment in education (for example, at the community college level), the disaggregation of complex tasks into simple functions that could be executed by mid-skill workers — may only slow the decline, not stop it. This is a deeply pessimistic vision.

“In my dystopian vision of the future, that red line (in the chart) keeps falling down – or suddenly drops off a cliff,” McAfee told The Times, adding: “All of the trends that I see and can identify are contributing to the hollowing out of the economy.”

In a videotaped interview on Bloomberg News, Brynjolfsson was somewhat more cautious:

I have to be brutally honest, I don’t think Andy and I are sure whether it’s different this time around. If you look at the data, this time it seems to be a lot more difficult. So it’s possible we are facing a regime change, a fundamental change in the way technology and employment interact with each other.

The Brynjolfsson-McAfee message has been generally well received in the high-tech community. On July 5, McAfee held the attention of an audience of young researchers and prospective entrepreneurs here at Singularity University. For over an hour after his lecture, students met with McAfee to explore the consequences of his argument.

The students’ questions:

How much can wealth accumulate for a small slice of the population at the top, while large numbers of people are forced to work for ever lower pay or to drop out of the workforce altogether? For such a future society to function, would wealth need to be (coercively) redistributed from the top to those below, in order for the mass of the jobless population to survive? Who would have power and how would tax and spending policies be determined in such a radically bifurcated, automated, workless society?

Many reviews of “Race Against The Machine” have been favorable, including those in publications supportive of free markets, including the Economist and the Financial Times.

McAfee noted in our interview that some critics have accused him and Brynjolfsson of accepting the “lump of labor fallacy” (the idea that there is a fixed amount of work available) in defiance of economic history. In the aftermath of major periods of technological advance, including the transition from agriculture to industry, employment has grown enormously.

James Hamilton, an economist at the University of California, San Diego, challenged the “Race Against The Machine” thesis in an e-mail to The Times:

I am very skeptical of the claim that technology itself is the problem. In 2005, the average U.S. worker could produce what would have required 2 people to do in 1970, what would have required 4 people in 1940, and would have required 6 people in 1910. The result of this technological progress was not higher unemployment, but instead rising real wages. The evidence from the last two centuries is unambiguous — productivity gains lead to more wealth, not poverty. The unemployment since 2007 was not caused by gains in productivity or increased automation, but instead by loss of demand for the product that the workers had been producing, for example, a plunge in the demand for new home construction.

Amar Bhidé, author of the book “The Venturesome Economy,” and senior fellow at the Center for Emerging Market Enterprises at Tufts, did not mince words responding to a request for comment from The Times:

As you might guess I find the storyline rather unconvincing and Luddite. What’s new about automation? I’ve been banging away for years about the phenomenon of non-destructive creation as a vital complement to creative destruction. The two don’t move in lock step but I have no reason to believe that non-destructive creation has ceased. Until someone persuades me it has, I will limit my anxieties to global warming, financial misregulation, a screwed up health care system, etc.

McAfee countered in an e-mail that “this time really is different,” arguing:

All previous waves of automation affected only a small subset of human skills and abilities. To oversimplify a bit, the industrial revolution was about building machines that had (much) more brute strength than we did. For all mental work, the industrial revolution was meaningless — you still needed people.

Until recently, the digital revolution also didn’t affect that many human skills and abilities. Computers became better at math, and at some clerical abilities, but we people were still miles ahead in other areas. So employers needed to hire humans if they wanted to listen to people speak and respond to them, write a report, pattern-match across a large and diverse body of information, and do all the other things that modern knowledge workers do.

Employers also needed people if they wanted lots of physical tasks done, including driving a truck or vacuuming a floor. The same with most tasks involving sensory perception, such as determining if a soccer ball has crossed a goal line.

All of the above abilities have now been demonstrated by digital technologies, and not just in the lab, but in the real world. So employers are going to switch from human labor to digital labor to execute tasks like those above. In fact, they’re already doing so. I expect this process of switching to accelerate in the future, perhaps rapidly, because computers get cheaper all the time, are very accurate and reliable once they’re programmed properly, and don’t demand overtime, benefits, or health care.

Brynjolfsson, who is more optimistic, said in an interview with The Times, “we are hopeful that that (job growth) will happen, but there is no guarantee of it. There is no economic law that says everyone benefits from technological improvement.” He also pointed out that the surge in inequality driven by rising incomes at the very top of the distribution suggests strongly that the benefits of digitization have not been widely spread.

“The problem is not tech stagnation,” as some have argued, “but the opposite,” Brynjolfsson contends. “Technology is rushing ahead faster than humans can adapt.” The difficulty of human adaptation is, in turn, likely to get worse, he added, because technological innovation — as in Moore’s Law (predicting a doubling of computer capacity roughly every two years) — grows exponentially in scope. The total number of non-farm jobs in the country is now 5 million less than in January, 2008. The 3.7 million jobs added to the economy have not been enough to make up for the 8.7 million jobs lost in 2008-9.

Brynjolfsson and McAfee have a list of 19 proposals that they support — which range from massive investment in education, infrastructure and basic research, to lowering barriers to business creation, eliminating the mortgage interest deduction and changing copyright and patent law to encourage new (as opposed to protecting old) innovations.

Any effort to ameliorate the damaging consequences to the employment marketplace stemming from technological innovation, according to Brynjolfsson, requires substantial government action at a time when “the political system is the most dysfunctional part of our society.”

McAfee and Brynjolfsson argue that in a race against machines, humans will lose. In their view, “the key to winning the race is not to compete against machines but to compete with machines.” The question, then, will be whether humans can adapt at anywhere near the pace needed to keep up.

I've been hesitant to write about the LIBOR scandal because what I want to say goes so much further. We now know that Barclays and other major global banks have been manipulating the calculation of LIBOR through the quotation data they provided to the British Bankers Association. What I suspect is that this is not a flaw but a feature of modern financial markets. And if it was happening in LIBOR for between 5 and 15 years, then the business model has been profitably replicated to many other quotation-based reference prices.

Price discovery is not a sexy function of markets, but it is critical to the efficient allocation of scarce capital and resources, and to the preservation of the long term wealth of investors and the economy as a whole. If price discovery is compromised by manipulation, then we will all be gradually impoverished and the economy will be imbalanced and unstable.

Over the past 25 years the forces of regulatory liberalisation and demutualisation of markets have allowed the largest global banks to set the rules, processes and infrastructure of global markets to their own self-interested requirements. Regulatory complexity and harmonisation benefit the biggest banks disproportionately, eroding the competitive stance of smaller, local banks and market participants. This has led to a very high degree of concentration in a very few banks in most markets that determine global reference rates for interest rates, currencies, commodities and investments. If those few collude with each other - as Adam Smith warned was always the result - then they impoverish us all.

We have allowed markets to evolve in ways that make supervision of markets almost impossible. Many instruments trade off-exchange or in multiple venues, making it nearly impossible for any single investor or regulator to supervise trading to prevent or detect manipulation or abuse. Many financial instruments are now synthetic compilations of underlying assets and derivatives, with multiple pricing components determined by reference to other prices or rates. Demutualisation and regualtory reforms stripped exchanges of the self-regulating interest in preventing manipulation and abuse by their members as mergers, profits and market share came to dominate governance objectives.

Off-exchange trading has been allowed to proliferate, creating massive ill-transparent and largely illiquid markets in almost every sector of finance. Pricing in these markets is based around calculated reference rates which, like LIBOR, are open to abusive quotation and data input practices. Many OTC derivatives are priced and margined using reference rates calculated against quotations unrelated to actual reported transactions. Synthetic securities such as ETFs are another example of an instrument that prices off a reference rate rather than the actual contents of an underlying asset portfolio. These instruments are open to consistent abusive pricing as a means of incrementally impoverishing those market participants who are the krill on which the global banks thrive.

How has it been possible for banks to grow from less than 4 per cent of the global economy to more than 12 per cent of the global economy without impoverishing others? How has it been possible for profits in the financial sector to be consistently higher than profits from other human endeavors with more tangible products or impacts on our daily lives - such as agriculture, transport, health care or utilities? How has it been possible that banks derive their profits not from the protected and regulated activities of deposit-taking and lending, but from the unsupervised and often unknowable escalation of off-balance sheet assets and liabilities? How has it been possible that pension savings have increased while pension returns have declined to the point where only bankers can expect a comfortable old age? Global banks have built the casinos and tilted the odds in the house's favour by rigging the data that determines the outcomes of most of the bets on the table. Every one of us that sits at the table long enough - whether saver, investor, borrower, taxpayer or pensioner - will be a loser. It is not a flaw; it is feature.

There is a reason that financial infrastructure used to be dominated by mutuals. Mutual gain and mutual liability created a natural discipline on excess and on rogue elements that would impoverish their peers.

There is a reason why trading was restricted to exchanges, and exchanges and clearing houses used to be self-regulating, and even had responsibility for resolution and liquidation of their members. Direct responsibility, authority and financial control meant that they could exert very powerful and immediate consequences on those members identified as abusing the market or investors.

The investigations into market rigging are just beginning. Paul Tucker opened the box yesterday when he admitted that he could not know whether the abuses discovered in setting LIBOR had spread to other synthetically calculated reference rates. As events unfold, it may be that we begin to appreciate just how deeply vulnerable we have become to predation by bankers with no stake in a local economy or in the local quality of life of the people they impoverish. A reckoning is needed, and then a rebalancing toward more local and mutual provision of essential services and market infrastructure that servers markets rather than those few bankers on the board.

As a start, regulators should consider punitive restrictions on the sale of instruments which price on reference rates unrelated to reported market transactions or underlying asset portfolios. Pricing should reflect real market transactions rather than guesstimates talking the banker's book.

We need to rethink as a society what banks are for, what exchanges are for, and what clearing houses are for. If they are for the profit of the few at the expense of the many now, that is because it is the business model we have permitted. If banks, markets and clearing are protected because they have a social function, we should make certain that social function is adding value. If it isn't, then we need some new models and some new rules.

I think this article really misses the mark. It is not the lack of regulatory oversight which ruins markets, it is exactly the opposite. Markets that are heavily regulated are inefficient, and like this Libor story, can be manipulated easily. In contrast, futures markets and over the counter markets are very efficient. Only the big boys play in those markets, and if you're stupid you don't last very long. The bond market itself is a great example. There is no government regulatory body which supervises the bond market. It's mostly over the counter, with lots of private exchanges popping up. No exchanges. People trade billions of dollars with a phone call and they write down their deal with pencil on paper. If you are not good for your word, you are forever banned. If you try to cheat people, you are history. When government regulators step in to intermediate, then the bond between buyer and seller is broken, and corruption can enter. Just like with charity: when the government gets into the business of charity, then people get out. Families don't take care of each other because that's the government's job. Society breaks down. You get the picture.

All those who complain that markets are flawed and inefficient and corrupt and need more regulation are completely wrong. Free markets always work. The problem comes when they aren't free to begin with, which is the case, unfortunately, for more and more markets these days.

Thanks Crafty for the original post and the Scott Grannis reply, I was hoping someone like that would answer it. I have not followed LIBOR but with other crises and scandals of the past, the worst situations seem to arise out of the botched regulation/ partial deregulation combinations. S&L's in the past completely had their hands tied down to interest rates defined to the quarter of a point, then they had more discretion but still with their hands tied for failure. The more recent banking collapse is a similar example. Insist on lending for criteria other than creditworthiness, pass laws that disrupt investment and asset markets then watch them collapse. Not really puzzling.

"How has it been possible for banks to grow from less than 4 per cent of the global economy to more than 12 per cent of the global economy without impoverishing others? "

I don't think it is the impoverished that pay most banking fees, but prices and fees get exorbitant when government blocks competition with all the licensing and regulations, some necessary and appropriate and some not. I try to pay no direct fees to banks, but if you are trying to take your company public or entering into mergers and acquisitions, paying a bank a reasonable fee for competent handling of those transactions and for access to liquidity may add quite a lot of value. Maybe you choose or require the best, a Morgan Stanley or whoever is still out there. But if their fees are outrageous, doesn't that open the door to competition, newer smaller firms who can do the same service for less. The question really is - why is the door closed to aggressive price competition that all real markets experience? And the answer to that for sure is the government regulations and compliance complexities that go with them.

As Grannis suggests, the fees and scope of it all is so expensive because the regulations are so multi-layered and complex that only a few elite firms are able to handle the most complex transactions.

Note how at the end, after all that detail and expertise, the greater regulations solution is left totally vague: "...then we need some new models and some new rules."

Isn't that exactly how we got Dodd-Frank? We needed new rules because we needed new rules so here they are, more and more layers of complexity and so what of the consequences.

What I don't exactly get in banking today is the collusion between the Fed and the private banks. They aren't lending money that other people saved anymore. They are lending nothing but manufactured or printed money. Good luck putting that toothpaste back in the tube.

Here's a response to Scott from , , , elsewhere. Its content could be posted on the Burearucracy thread, but in the interest of continuity I post it here:==============================Amen, Scott. The complexity cited in the article just reinforces the point that regulation is impossible. Regulation of an industry is de facto central planning. Centrally planned economies do not work, period.

Perhaps not relevant, but consider some lessons out of aviation, something I know a bit about as I now teach classes on portions of aviation regulation here in Australia.

Aviation is probably even more regulated than banking, but a radical increase in regulation a few years ago did not increase safety, the objective of most aviation regulations. Bureaucrats wrote more and more specific and voluminous rules about WHAT to do and HOW to do it down to the finest detail, and then inspected and wrote lots of violations that focussed on paperwork, reporting, detail, etc. It yielded negligible improvement.

Indeed, since (inevitably) the ultra detailed regulations were written by lawyers, they were incomprehensible to others. In Australia the regulations for how to coordinate maintenance when doing a "C check" (major inspection) on an airliner are pages long, and despite my attempts to read them, proved to be incomprehensible.

Yet mechanics are supposed to comply with chapter and verse of gobbledygook text.

Airlines spent millions writing procedures manuals understandable by mere mortals and then getting them checked out to assure they stayed legal. There was no room for improvement or innovation. Slavish adherence to procedure was required.

Now, introduce a new change in technology, and it all starts over again. Huge amounts of paper, huge amounts of money not focussed on the core issues, and no benefits derived. Ass hole government inspectors (and t hey are a round) had a field day writing violations for the slightest infractions.

Then another approach emerged and is now filtering through the system. Instead of detailing down to the finest level how and what to do, regulations are being shifted to become "performance requirements." In this mode, the regulation indicates what RESULT is desired. The regulation is then supported by an "advisory document" prepared by the same folks who wrote the performance requirement. It outlines one way to achieve the desired level of performance if you are not sure how to do so. If you do it in accordance with the advisory document, you know you are legal.

BUT, the regulation also indicates that "alternative means of compliance" are also OK as long as they achieve the desired level of performance.

Surprise, surprise, this option for an alternative means of compliance has led to lots of innovation as new ideas are floated and reviewed and then implemented. Periodic audits make sure alternative methods are still working and the desired performance levels are being achieved.

And it works. Surprise surprise.

I am not sure if such lessons can be transferred to bank regulation, but it is clear that what has thoroughly pissed everyone off is that banks have failed to satisfy our general expectations regarding performance of an important element of our society (banking). So a focus on how to achieve performance would seem to be the key.

EBay reputation tracking is a public market version of what Scott G posted for bond traders' reputations, keeping their word off a phone call and a hand written note. I wouldn't argue for no regulation but I would guess that would be more effective than what we have now.

John B. TaylorThe Road to RecoveryAs Hayek taught, freedom and the rule of law drive prosperity.Friedrich Hayek, second from left, at the London School of Economics in 1948Paul Popper/Popperfoto/Getty ImagesFriedrich Hayek, second from left, at the London School of Economics in 1948

Burdened by slow growth and high unemployment—especially long-term unemployment—the American economy faces an uncertain future. We have endured a painful financial crisis and recession, the recovery from which has been nearly nonexistent. Federal debt is exploding and threatening our children and grandchildren. In my view, the reason for this predicament is clear: we have deviated from the principles of economic freedom upon which America was founded.

Few thinkers of the past century understood the importance of economic freedom better than the Austrian economist Friedrich Hayek did. As we confront our current situation, Hayek’s work has much to tell us, especially about policy rules, the rule of law, and the importance of predictability—topics that he discussed in his classic The Road to Serfdom (1944) and in greater detail in The Constitution of Liberty (1960). But his work in these areas goes beyond economics into fundamental issues of freedom and the role of government. That’s why reading Hayek is more important than ever.

As Hayek would insist, we need to be careful about what we mean by economic freedom. The basic idea is that people are free to decide what to produce, what to buy, where to work, and how to help others. The American vision, as I explain in my book First Principles, held that people would make these choices within a policy framework that was predictable and based on the rule of law, with strong incentives emanating from a reliance on markets and a limited role for government. Historically, America adhered to these principles more than most countries did, a major reason why the nation prospered and so many people came to these shores.

But we haven’t always followed the principles consistently. Leading up to the Great Depression, the Federal Reserve cut money growth sharply, deviating from a predictable policy framework. The federal government then worsened the Depression by raising tax rates and tariffs and by passing the National Industrial Recovery Act, which overrode market principles and went well beyond sensible limits on government. From the mid-1960s through the 1970s, federal policy again deviated from the principles of economic freedom: the era saw unpredictable short-term stimulus packages, discretionary “go-stop” monetary policies, and wage and price controls—the antithesis of an incentive-based market system. The results: double-digit unemployment, a severe slowdown in economic growth, and the Great Inflation. Well before that time, Hayek had rightly lamented such short-term approaches: “I cannot help regarding the increasing concentration on short-run effects . . . not only as a serious and dangerous intellectual error, but as a betrayal of the main duty of the economist and a grave menace to our civilization.”

In the 1980s and 1990s, America moved back toward its first principles, a restoration that lasted until recently. Temporary stimulus programs were out; permanent tax reform was in. Steady-as-you-go monetary policy replaced go-stop monetary policy. We removed the last vestiges of price controls and reduced inappropriate regulations. The major federal welfare program devolved to the states. The results this time: declining unemployment, lower inflation, and eventually a revival of economic growth.

Now we have tragically gone off the path again. Leading up to the latest downturn, the Federal Reserve held interest rates too low for too long, deviating from the rules-based monetary policy that had worked so well in the 1980s and 1990s. Government regulators failed to enforce existing rules on banks and other financial institutions, including Fannie Mae and Freddie Mac. The resulting crisis prompted the Wall Street bailouts, which soon extended beyond their original mission. The auto-company bailouts resulted in arbitrary infringements on creditors’ rights and interventions into business operations. Then came the return of the failed stimulus packages of the 1970s, the Fed’s quantitative easing, and the regulatory uncertainty associated with the 2010 health-care legislation and the Dodd-Frank financial-reform law—which gives government the discretionary authority to take over any failing financial firm and rescue its creditors.

One sign of the increase in policy uncertainty is that over the past 12 years, the number of provisions of the tax code expiring annually has increased tenfold. Another is that the number of federal workers engaged in regulatory activities (excluding those in the Transportation Security Administration) has grown by 25 percent from 2007 to 2012. Most emblematic of the deviation from our basic principles is the self-inflicted fiscal cliff that we face at the end of this year, when virtually the entire tax code will change. And the Fed has effectively replaced the money market with itself, setting a zero-percent interest-rate policy through 2014.

Government policy has largely caused these problems. It follows that we can restore prosperity by changing the policy and implementing a plan based on our core economic principles. We should reduce federal spending, as a share of GDP, to what it was in 2007, which would let us balance the budget and stop the debt explosion with revenue-neutral, pro-growth tax reform. We should unwind our monetary excesses and normalize monetary policy, using a rules-based system of the kind that worked well in the 1980s and 1990s. We should halt the rapid expansion of the entitlement state, keeping entitlement spending growth close to GDP growth and doing it in a way that gives decision-making responsibility to people and states, rather than to the federal government. And we should replace most of Dodd-Frank with bankruptcy reform and simpler regulations, with the goal of ending government bailouts.

In implementing this new economic strategy, policymakers should be guided by Hayek, especially by his emphasis on the rule of law and the predictability of policy. As he wrote in The Road to Serfdom, “Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law. Stripped of all technicalities, this means that government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge.”

Rules-based policies produce more stable economies and stronger economic growth. When people make decisions, they look to the future. Prices that convey information and provide incentives reflect the future. So good decisions as well as the prices that guide them depend on the predictability of future policy—and thus on clear policy rules.

But Hayek emphasized that rules for government policy do something more. The rule of law protects freedom, as the title of Hayek’s The Constitution of Liberty suggests. Hayek traced this idea through the ages—first to Aristotle, then to Cicero, about whom Hayek wrote: “No other author shows more clearly . . . that freedom is dependent upon certain attributes of the law, its generality and certainty, and the restrictions it places on the discretion of authority.” Hayek also cited John Locke, who wrote that the purpose of the law was “not to abolish or restrain, but to preserve and enlarge freedom. . . . Where there is no law, there is no freedom.” Finally, Hayek pointed to James Madison and other American statesmen who put these ideas into practice in a new nation. These thinkers distrusted government officials as protectors of freedom; the rule of law, they believed, was more reliable.

So rules have a dual purpose: encouraging economic growth and protecting freedom. The best way to understand the two advantages of rules is to examine what happens in their absence, as in the case of wage and price controls. Such controls are arbitrary: they require decisions by people at the top about virtually every price and wage; they distort economic signals and incentives; they create shortages and surpluses. These effects occur whether the price controls are imposed on the whole economy or on a particular sector, such as health care.

Many wonder how a system of rules can work in practice, with politicians and government officials continually pressured to “do something” about economic problems. Rules mean that you do nothing, say the skeptics, and that’s impossible in today’s charged political climate and hour-to-hour, even minute-to-minute, news cycle. My colleague George Shultz calls the problem “the urge to intervene.”

Hayek had an answer to that challenge. In The Road to Serfdom, he pointed out the need to clear up a “confusion about the nature of this system” of formal rules: “the belief that its characteristic attitude is inaction of the state.” Offering one example of a rules-based system, he noted that “the state controlling weights and measures (or preventing fraud or deception in any other way) is certainly acting.” By contrast, a system in which the rule of law was flouted wasn’t necessarily characterized by action: “The state permitting the use of violence, for example, by strike pickets, is inactive.” Similarly, simple rules for monetary policy don’t mean that the central bank, in response to events, takes no action at all with interest rates or the money supply. The bank might provide loans in the case of a bank run, for instance. But these actions can be taken in a predictable manner. For that matter, deviation from the rules sometimes results in inaction. A decision by government regulators not to act when financial institutions take on unreasonable risks, for example, constitutes both inaction and a violation of the rule of law.

Some argue that crises like the present one force policymakers to deviate from rules and the rule of law. But a crisis may be the worst time to do so. In a crisis, what is vital is increased strategic clarity, not increased unpredictability. That fact became clear following the first bailout of the recent crisis, the Bear Stearns intervention: few knew what to expect the next time a financial institution wanted help, since no strategy had been articulated. The crisis worsened. The sooner people can make decisions with knowledge of the rules, the sooner recovery will come about.

To get America back on track, we must choose leaders who believe in the principles of economic freedom and will implement them. But here, Hayek issued a warning. In a chapter in The Road to Serfdom called “Why the Worst Get on Top,” he suggested that people with the ambition to become leaders, either by election or by appointment, are often interventionists, since their tendency is to do whatever it takes to succeed. Further, those who benefit directly from discretionary government interventions naturally support such officials. Industries and firms that benefit from bailouts will favor officials comfortable with bailouts, for example, and even academic research on economic policy will become biased toward interventionism. Perhaps the answer to Hayek’s warning is to elect or appoint people regarded as overly committed to the principles of economic freedom. Then, after experiencing the heavy pressure pushing them toward intervention, they may emerge with a sensible balance. In the 1980s, Ronald Reagan took this tack, appointing many Ph.D.s from the University of Chicago’s free-market school of economics to positions of leadership.

John Maynard Keynes took a different view. In a famous letter to Hayek about The Road to Serfdom, Keynes expressed his preference for more interventionist appointees—but he wanted only those whom he viewed as beneficent interventionists. “What we want is not no planning, or even less planning, indeed I should say we almost certainly want more,” Keynes wrote. “But the planning should take place in a community in which as many people as possible, both leaders and followers, wholly share your own moral position.” Milton Friedman later cited this letter to illustrate Keynesianism’s defining characteristic: its focus on discretionary interventions taken by people in powerful government positions.

Even those who support the principles of economic freedom can sometimes get off track. One might argue that such deviations were needed in the fall of 2008; perhaps the actions taken then prevented a more serious panic. But that’s no reason to embrace the discretionary policies that led to the mess in the first place. Such an argument is like saying that the person who set fire to a house should be exonerated because he then put out the fire and saved a few rooms.

Is today’s departure from economic freedom any less serious than the assault on freedom that Hayek wrote about in The Road to Serfdom? Am I exaggerating when I say that the future of American prosperity—or even global prosperity—is at stake?

While central planning may not be the right term for it, consider the 2010 health-care law, which gave the federal government the power to mandate the terms of everyone’s health-insurance package and which created an Independent Payment Advisory Board to determine the price, quantity, and quality of the medical services—from number of MRIs to the necessary accuracy of CT scans—that a medical professional provides. Is that so different from the way centrally planned economies determine the price, quantity, and quality of livestock, wheat, or steel that can be produced? Or consider monetary policy. A few years ago, I coined the term “mondustrial policy” to describe the Fed’s practice of quantitative easing, which combined industrial policy (discretionary assistance to certain firms and industries) with monetary policy (printing money to finance that assistance). Since then, the Fed has purchased $1.25 trillion of mortgage-backed securities. In fiscal year 2011, it purchased 77 percent of the newly issued federal debt, long after panic conditions had subsided.

Hayek argued that inflationary monetary policy undermines economic freedom, in part because it hits the elderly and the poor particularly hard, rationalizing more discretionary interventions. Though the inflation problem is less severe now than in the 1970s—at least so far—the impact of the Fed’s multiyear, zero-percent interest-rate policy resembles that of the Great Inflation era: it significantly cuts real incomes for those who have saved over a lifetime for retirement.

By moving away from the basic principles of economic freedom, government policy has caused our recent economic malaise. It should be no consolation that some of our friends in Europe are facing worse economic struggles, often because they moved even further away from those principles. The good news is that a change in government policy will alleviate the problems and help restore economic prosperity. Understanding Hayek’s work, written during similar circumstances, will help us greatly as we undertake that difficult task.

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the George P. Shultz Senior Fellow in Economics at the Hoover Institution. His article is adapted from the 2012 Friedrich Hayek Lecture, which he delivered on winning the Manhattan Institute’s Hayek Prize.

Posted on July 31, 2012 by Steven Hayward in Conservatism, EconomyMilton Friedman at 100

Today is Milton Friedman’s 100th birthday. It is one of the great privileges of my life to have known him some, and to have spent some time with him in San Francisco back in the 1990s. Driving with him up and down the hills of San Francisco was not for the faint of heart. All of his rational calculations of risk seemed to go out the window when he was behind the wheel of his Lexus. And one of my cherished possessions is the very kind note Milton sent to tell me how much he enjoyed the first volume of my Age of Reagan books, where he makes several appearances.

Thomas Sowell, a student of Milton’s at Chicago, recalls him here. My pal Steve Moore also recalls his importance in the Wall Street Journal today, calling him “The Man Who Saved Capitalism.”

In the 1960s, Friedman famously explained that “there’s no such thing as a free lunch.” If the government spends a dollar, that dollar has to come from producers and workers in the private economy. There is no magical “multiplier effect” by taking from productive Peter and giving to unproductive Paul. As obvious as that insight seems, it keeps being put to the test. Obamanomics may be the most expensive failed experiment in free-lunch economics in American history.

Equally illogical is the superstition that government can create prosperity by having Federal Reserve Chairman Ben Bernanke print more dollars. In the very short term, Friedman proved, excess money fools people with an illusion of prosperity. But the market quickly catches on, and there is no boost in output, just higher prices.

I might (but might not) quarrel slightly with Steve’ second paragraph here, as it seems velocity—one of the key terms of Friedman’s basic equation of monetarism (MV=PQ) fell sharply during the recession and may still be off, though it is hard for the layman to tell. We visited this subject once before, and it brings vividly to mind a dinner I once enjoyed with Milton and the president of a regional Fed bank in the early 1990s in San Francisco, and I was immediately in way over my head as they argued the virtues and defects of the M1, M2, and M3 measures of the money supply. Even among monetarist economists, there are serious and honest differences in evaluating the economy and prescribing the right monetary course. (Though one thing Milton was absolutely against was the gold standard. I learned that in my very first conversation with him way back in the 1980s.)

Easier to grasp is Milton’s piercing of the pretentions of things like Obama’s stimulus. My all time favorite Milton story involves the time he was motoring in Europe, and noticed a large group of men digging in a field with shovels. Milton asked someone why they didn’t use a steam shovel or earth mover, and was told that digging with shovels was an employment measure, and if they used an earth mover it would put people out of work. To which Milton naturally followed up: “Then why don’t you give them spoons?”

There are lots of good videos of Milton on YouTube, many of them drawn from his fabulous “Free to Choose” television series. But my favorite for today is this very short smackdown of Phil Donahue on the subject of “greed.” Enjoy! (UPDATE: A faithful correspondent reminds me about the Milton Friedman Choir, singing about the corporation, so I’ve added this one, too.)

Arthur Laffer: The Real 'Stimulus' Record In country after country, increased government spending acted more like a depressant than a stimulant.By ARTHUR B. LAFFER

Policy makers in Washington and other capitals around the world are debating whether to implement another round of stimulus spending to combat high unemployment and sputtering growth rates. But before they leap, they should take a good hard look at how that worked the first time around.

It worked miserably, as indicated by the table nearby, which shows increases in government spending from 2007 to 2009 and subsequent changes in GDP growth rates. Of the 34 Organization for Economic Cooperation and Development nations, those with the largest spending spurts from 2007 to 2009 saw the least growth in GDP rates before and after the stimulus.

The four nations—Estonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth. The United States was no different, with greater spending (up 7.3%) followed by far lower growth rates (down 8.4%).

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Close..Still, the debate rages between those who espouse stimulus spending as a remedy for our weak economy and those who argue it is the cause of our current malaise. The numbers at stake aren't small. Federal government spending as a share of GDP rose to a high of 27.3% in 2009 from 21.4% in late 2007. This increase is virtually all stimulus spending, including add-ons to the agricultural and housing bills in 2007, the $600 per capita tax rebate in 2008, the TARP and Fannie Mae and Freddie Mac bailouts, "cash for clunkers," additional mortgage relief subsidies and, of course, President Obama's $860 billion stimulus plan that promised to deliver unemployment rates below 6% by now. Stimulus spending over the past five years totaled more than $4 trillion.

If you believe, as I do, that the macro economy is the sum total of all of its micro parts, then stimulus spending really doesn't make much sense. In essence, it's when government takes additional resources beyond what it would otherwise take from one group of people (usually the people who produced the resources) and then gives those resources to another group of people (often to non-workers and non-producers).

Often as not, the qualification for receiving stimulus funds is the absence of work or income—such as banks and companies that fail, solar energy companies that can't make it on their own, unemployment benefits and the like. Quite simply, government taxing people more who work and then giving more money to people who don't work is a surefire recipe for less work, less output and more unemployment.

Yet the notion that additional spending is a "stimulus" and less spending is "austerity" is the norm just about everywhere. Without ever thinking where the money comes from, politicians and many economists believe additional government spending adds to aggregate demand. You'd think that single-entry accounting were the God's truth and that, for the government at least, every check written has no offsetting debit.

Well, the truth is that government spending does come with debits. For every additional government dollar spent there is an additional private dollar taken. All the stimulus to the spending recipients is matched on a dollar-for-dollar basis every minute of every day by a depressant placed on the people who pay for these transfers. Or as a student of the dismal science might say, the total income effects of additional government spending always sum to zero.

Meanwhile, what economists call the substitution or price effects of stimulus spending are negative for all parties. In other words, the transfer recipient has found a way to get paid without working, which makes not working more attractive, and the transfer payer gets paid less for working, again lowering incentives to work.

But all of this is just old-timey price theory, the stuff that used to be taught in graduate economics departments. Today, even stimulus spending advocates have their Ph.D. defenders. But there's no arguing with the data in the nearby table, and the fact that greater stimulus spending was followed by lower growth rates. Stimulus advocates have a lot of explaining to do. Their massive spending programs have hurt the economy and left us with huge bills to pay. Not a very nice combination.

Sorry, Keynesians. There was no discernible two or three dollar multiplier effect from every dollar the government spent and borrowed. In reality, every dollar of public-sector spending on stimulus simply wiped out a dollar of private investment and output, resulting in an overall decline in GDP. This is an even more astonishing result because government spending is counted in official GDP numbers. In other words, the spending was more like a valium for lethargic economies than a stimulant.

In many countries, an economic downturn, no matter how it's caused or the degree of change in the rate of growth, will trigger increases in public spending and therefore the appearance of a negative relationship between stimulus spending and economic growth. That is why the table focuses on changes in the rate of GDP growth, which helps isolate the effects of additional spending.

The evidence here is extremely damaging to the case made by Mr. Obama and others that there is economic value to spending more money on infrastructure, education, unemployment insurance, food stamps, windmills and bailouts. Mr. Obama keeps saying that if only Congress would pass his second stimulus plan, unemployment would finally start to fall. That's an expensive leap of faith with no evidence to confirm it.

Mr. Laffer, chairman of Laffer Associates and the Laffer Center for Supply-Side Economics, is co-author, with Stephen Moore, of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).

What's in your wallet?By Robert Klosefrom the March 31, 2008 editionPeople carry money about, save it, and spend it, but often know almost nothing about it.I teach biology at a college here in Maine. Sometimes the lessons proceed in unanticipated directions.This is exactly what happened recently during a laboratory exercise. The topic was taxonomy – the classification of living things. Using American money as an example of how things are logically ordered, I asked my students to write a classification scheme that would divide the various denominations into groups with related features. "Think of characteristics shared by different coins and bills," I instructed. "For example, the coins have a Latin motto."What Latin motto? Most had never heard of a Latin motto. So I told them to take out a coin and look for something that wasn't in English. They found it, but it was as if they had never seen it before. "E Pluribus Unum." Out of many, one. A beautiful motto. One of the best. It certainly has more gravity than Aruba's motto, "One Happy Island."My students' lack of knowledge about the national motto piqued my curiosity. I told them to put their money away. Then I took out a handful of change and a few bills. "Who's on the penny?" I asked. Most of them knew that it was Lincoln.Then I asked the next logical question: What's on the back of the penny? Two people said, "A house." Not one of the 20 named the Lincoln Memorial.All right, then. On to the nickel. Who's the guy on the nickel? Two people got Jefferson right, but none of them knew what was on the back of this coin: Monticello. My biology laboratory was quickly becoming a lesson in numismatics, US history, and literacy."Don't you folks ever read your money?" I chided.One replied (and I should have seen this coming), "No, we just spend it!"There it was, then. My students took money completely for granted. They carried it about, saved it, spent it, lost it, sought it, but knew almost nothing about it. As an erstwhile coin collector, I was happy to share my expertise. "Why do some coins have grooved edges?" I asked. What I got in return was the obvious answer: so blind people can tell them apart. While this is certainly one of its benefits, it wasn't the original impetus for the feature. Grooved, or reeded, coins were introduced as a guard against people shaving the edges of gold and silver pieces and then passing the coins back into circulation.From there, we went on to a conversation about hairdos. Why did George Washington wear a wig? A few shrugs from my audience gave way to one suggestion that it was "just the style" back then. Well, this is partially correct, but it had more to do with hygiene. Colonials did not believe in frequent bathing, for fear it would wash away the body's essential oils. The result was lice. In many men, this unseemly condition was compounded by natural hair loss, so it was easier to shave one's head and care for a wig, which was often made from the hair of horses or goats.At this point, my students were leaning forward, their eyes bright. It was clear that the idea of a president wearing a wig with a ponytail and bow – a real hepcat – was far more interesting than a discussion of the taxonomic position of the blowfish.We moved on to paper money. "Who's on the dollar?" I asked, as if positing the opening question of "Who Wants to be a Millionaire?" Washington was a no-brainer for them. Lincoln on the five-spot was also an easy one, Hamilton on the $10 stumped a few, Jackson on the $20 a few more, and only one person placed Grant on the $50. None of them knew that Hamilton was the only one of these men who was never president.How about the $100 bill? Interestingly, most knew Ben Franklin. But I left them in the dust when I asked them about the now-extinct $500, $1,000, and $5,000 notes (William McKinley, Grover Cleveland, James Madison). And then, as a sort of coup de grâce, I brought out the big gun: "Who," I asked, "is on the $100,000 bill?"This one unsettled them. "There's no such thing!" one bold male exclaimed, to cheers of approbation for his taking a stand against the suggestion that such a large note could possibly exist."At one time there was," I said, calming the crowd. "And the portrait was of a First World War-era president."You mean, there was a war before the Second World War? Well, yes. But none of my students knew the name of the chief executive at the time (Woodrow Wilson).Our excursion through US currency and its lore was time well spent because the unspoken message it conveyed was that in science, it's important to be good observers, to look closely, and to ask questions. As we ended the topic, one student asked why a person would want to own a $100,000 bill."Actually, it's illegal for a private citizen to own one," I said. "They were used only for transactions between Federal Reserve banks.""What if I find one lying around?" asked the class wisecracker, generating a few supportive laughs."That's easy," I said. "Give it to me. I'll take care of it." And I certainly would.

THE UNITED STATES $1 BILL

Look at a $1 bill, which first came off the presses in 1957 in its then-current design. (Just a few years ago. A few changes since. -- dmg)

This so-called paper money is in fact a cotton and linen blend, with red and blue minute silk fibers running through it; it is actually material. We've all washed it without it falling apart. A special blend of ink is used, the contents we will never know. It is overprinted with symbols and then it is starched to make it water resistant and pressed to give it that nice crisp look.If you look on the front of the bill, you will see the United States Treasury Seal...

On the top you will find the scales for a balanced budget. In its center is a carpenter's square, a tool used for an even cut.Beneath is the Key to the United States Treasury.That's all pretty easy to figure out, but on the back of the dollar bill are items we all should know.Turn the bill over, you will see two circles; both circles, together, comprise the Great Seal of the United States...

The First Continental Congress requested that Benjamin Franklin and a group of men come up with a Seal. It took them four years to accomplish this task and another two years to get their design approved.Look at the left-hand circle, and see a Pyramid...

Notice...• The face is lighted, and the western side is dark. This country was just beginning. We had not begun to explore the West or decided what we could do for Western Civilization.• The Latin above the pyramid, ANNUIT COEPTIS, means, "God has favored our undertaking."• The Latin below the pyramid, NOVUS ORDO SECLORUM, means, "a new order has begun."• At the base of the pyramid is the Roman Numeral, MDCCLXXVI, or 1776.• The Pyramid is uncapped, again signifying that we were not even close to being finished. • Inside the capstone you have the all-seeing eye, an ancient symbol for divinity. It was Franklin's belief that one man couldn't do it alone, but that a group of men, with the help of God, could do anything. • "IN GOD WE TRUST" is on this currency.

Look closely at the right-hand circle...

which seal is on every National Cemetery in the United States, on the Parade of Flags Walkway at the Bushnell, Florida National Cemetery, and is the centerpiece of most hero's monuments. Slightly modified, it also serves as the seal of the President of the United States, always visible whenever he speaks, yet very few people know what the symbols mean.

The Bald Eagle was selected as a symbol for victory for two reasons...• He is not afraid of a storm; he is strong, and he is smart enough to soar above it.• He wears no material crown. We had just broken from the King of England. Note the shield...• Is unsupported. This country can now stand on its own.• At the top of that shield you have a white bar signifying Congress, a unifying factor. We were coming together as one nation.• In the Eagle's beak you will read, E PLURIBUS UNUM, meaning, "one nation from many people."• Above the Eagle, you have thirteen stars, representing the thirteen original colonies, and any clouds of misunderstanding rolling away. Again, we were coming together as one.• Notice the Eagle holds in his talons an olive branch and arrows:o This country wants peace, but we will never be afraid to fight to preserve peace.o The Eagle always wants to face the olive branch, but in time of war, his gaze turns toward the arrows.

Does this analysis hold with regard to US workers in the presence of Chinese capital and currency controls?

I agree with the analysis of the author. It is true that Romney is sounding complaints with unfair practices in China. That is fine to negotiate tough, but not to the point of imposing tariffs or closing off trade. A tariff would be a tax imposed on the American consumer, not the Chinese producer. Tasking our bureaucrats to even out all production irregularities in the world before you can buy a product is no solution. Our competitive disadvantage right now is mostly of our own making.

Posted before, globalization is both a) inevitable and b) beneficial. If you don't agree with b) please see a). We don't want international control over our own businesses and industries and we can't control theirs. Pollution is another matter from trying to control their labor market. We are also very capable of competing with and against the Chinese and everyone else. There are levers of negotiation in the complex relationships of the countries short of stopping trade.

I like to call it freedom to trade, the freedom to buy or sell almost anything almost anywhere in the world. (Not arms to enemies etc.) Both imports and exports are beneficial and both lead to a higher standard of living at home. The freest economies will compete the best and benefit the most. Hard to say if that is the US or China right now; I know they have a lower corporate tax rate.

Questions posed in the article: "Are bad jobs at bad wages better than no jobs at all?" - Yes and I'm not including any kind of slave or involuntary labor as a job.

GM, Nice charts. Welcome back! Ironic that the least free countries have the highest income inequality. You would think the chart showing the 25 most free countries with 7-fold more GDP per capita that the 25 least free countries telling it all would have some effect on policy makers somewhere...

Crafty: "I remain open to the idea that beggar-thy-neighbor exchange rate policies and capital controls present a problem. Yes? If so, how to solve?"

Probably mentioned before but there was quite a debate between some economic legends about fixed versus floating exchange rates between Robert Bartley former WSJ editor and Milton Friedman. We have a floating and only partially manipulated exchange rate between the US and Europe. Rates within the Euro are fixed thanks to some work by another legend Robert Mundell who thought that rigidity would force fiscal discipline in places like Greece etc. Oops. China and the growth economies of Asia pegged to the US$ and that worked well for them. By beggar thy neighbor I assume you refer to our accusation that China's rate is locked in too low. If true, and it probably is, it skews things but in total is no great advantage for China in the long run; that is is my understanding. So my answer to how to solve is jawbone them like Romney is doing but otherwise what is there? Devalue back? In a sense we are with QE. The real answer is in those charts from GM. Pursue economic freedom, compete in a global market like we mean business and let the chips fall where they may. If China prospers then they will start spending and consuming and caring what they have to pay for imports as part of their own standard of living.

"To combat depression by a forced credit expansion is to attempt to cure the evil by the very means which brought it about; because we are suffering from a misdirection of production, we want to create further misdirection -- a procedure which can only lead to a much more severe crisis as soon as the credit expansion comes to an end." --economist Friedrich August von Hayek (1899-1992)

Submitted by Joe Yasinksi and Dan Flynn of GBI,Have you seen Robert Triffin?

"It was the outcome of an unbelievable collective mistake, which, when people become aware of it, will be viewed by history as an object of astonishment and scandal"-Jaques Reuff 1972

The obscure Belgian economist Robert Triffin is not only very dead he also isn't exactly a household name, yet. Triffin, who died in 1993 studied at Harvard, taught at Yale, worked at the Federal Reserve, the IMF, and was a key contributor to the formation of the European monetary system.Triffin exposed serious flaws in the Bretton Woods monetary system and perfectly predicted it's inevitable demise yet his work remains largely ignored and unstudied by today's mainstream economists. This "flaw" became known as the Triffin dilemma, and many believe Triffin's dilemma has as serious implications today as it did 50 years ago. In short, Triffin proposed that when one nations currency also becomes the worlds reserve asset, eventually domestic and international monetary objectives diverge. Have you ever wondered how it's possible that the USA has run a trade deficit for 37 consecutive years? Have you ever considered the consequences on the value of your Dollar denominated assets if it eventually becomes an unacceptable form of payment to our trading partners? Thankfully for those of us trying to navigate the current financial morass, Robert Triffin did.

Prior to the 1944 Bretton Woods agreement, central banks used gold as the asset to back their currencies. By the end of World War II, the United States had established itself as the world's creditor and largest holders of gold. Under the 1944 Bretton Woods agreement, the US Dollar was fully backed by gold at a fixed value of 1/35th an ounce per dollar, and foreign Central Banks could use US Dollar assets as reserves backing their currency, in lieu of gold. This agreement avoided the inevitable deflationary pressure a return to pre-war gold/currency ratios would have forced just as Europe was beginning to rebuild, and allowed US debt held abroad to be used as an asset by central banks against their local currencies.

In the 1960's Triffin observed that there existed an excess of dollars offshore relative to the gold available to tender at the set $35 price. He hypothesized that given foreign central bank demand for dollars as reserves, the trend of a growing and continuing glut of dollars was going to continue unabated. It would continue until the excess reserves would so clearly be many multiples of the gold available to satisfy them that enough countries would start tendering dollars for gold and eventually the entire scheme would collapse. Triffin went as far as congress in 1960 to testify that the system as currently devised could not possibly maintain both liquidity and a stable value in the dollar and eventually, the agreement would prove unsustainable. As Triffin predicted, on August 15, 1971 the United States closed the gold window as Richard Nixon came on national television and defaulted on US gold obligations while national gold reserves drained from over 20,000 tons to 8,133 tons. Up until Nixons actions, foreign sovereigns tendered their dollars for gold at an increasing pace. On that day, nations that were holding US dollars because they were "as good as gold" were left with paper promises and nothing more.

At that time, the world was at a crossroads. Would foreign governments and trade partners continue to accept fully fiat US Dollars? The alternative was a deflationary return to a hard (pre-Bretton Woods) gold standard. It can be argued that structural support was granted to the dollar given the fact that with cheap oil, the US economy was expanding at a pace far more rapid than the growth in US government debt. They rationalized that US dollar was still a claim on future growth and production and the rest of the world was lifting it's standard of living as well.Going backwards to the last failed monetary regime was politically unappealing.

And so the US dollar hegemony continues to this day. The dollar is fully entrenched as the settlement currency for international trade. As of today if any nation wants to buy oil, the lifeblood of the global economy, they pay in dollars. This alone, along with demand for foreign reserves create an unnatural demand for US assets, specifically treasury debt. Robert Triffin opined that the collapse of Bretton woods did not solve his dilemma because the country that supplies the world with it's reserve asset in the form of their currency and debt will still be forced to supply an excess of this reserve to satisfy world demand and thus, run a trade deficit in perpetuity. Such a dynamic can not exist under the natural laws of economics, it can only survive only with active and unanimous political support and intervention.

The issue facing the modern United States is that since the rest of the world uses the US dollar as a reserve behind their own currencies, that demand has allowed the United States to run a deficit in perpetuity and the mechanics of this trade has allowed the US to export price inflation abroad. Quite simply, the US imports real goods in excess of the real goods it exports. The deficit balance minus service exports is made up with printed US dollars. Our trade partners ship/recycle the same dollars back to the United States in exchange for US Treasury Debt. The US Treasuries are held as reserves on the balance sheet of their central bank, and local currency printed against those new reserves. This process, although inflationary for our trade partner, allows them to keep their currency weak vs the US Dollar and prices cheap for US consumers.

Every nation on earth other than the United States has a limit to their potential trade deficit confined by their existing reserves plus their borrowing capacity. Not only does the US have the capacity to run a perpetual and growing trade deficit but the rest of the world actually demands us to run a balance of payment deficit or else their reserves will have to shrink, along with their credit, currency and economy. Good deal for us, no? This situation means that for 40 years our trade partners have not only tolerated, but dysfunctionally enabled our perpetual deficits. The United States has had the "exorbitant privilege" of being the issuer of the worlds' reserve currency. We've all enjoyed the benefits, now comes the pain.

Sure enough as Triffin foretold the US trade surplus began shrinking immediately after the collapse of Bretton Woods and transitioned to a permanent trade deficit by 1975, never to return to a surplus to date, 37 years later. The previously stable national debt (with a permanent ceiling of $400 billion dollars) has ballooned to over $16 trillion dollars, a multiple of 40 times what it was during the previous monetary regime. Given this 4-decade perpetual trade deficit with the rest of the world and "hyperinflation" of US dollar credits and claims, many have wondered how the US has avoided massive price inflation at home.

Triffin's dilemma continues to play an important role in the ongoing financial crisis the world has found itself in since 2008. The governor of the Peoples Bank of China specifically referenced Triffin's Dilemma as the root cause of the current financial disorder and suggested an immediate effort to transition away from the US dollar to avoid more catastrophic consequences.

The US Council on Foreign Relations aptly describes why Triffin's dilemma becomes unsustainable:

"To supply the world's risk-free asset, the center country must run a current account deficit and in doing so become ever more indebted to foreigners, until the risk-free asset that it issues ceases to be risk free. Precisely because the world is happy to have a dependable asset to hold as a store of value, it will buy so much of that asset that its issuer will become unsustainably burdened."

Have we reached the day when the United States has become unsustainably burdened? Can US debt honestly be considered to still be risk free? S&P certainly doesn't think so, neither does our second largest creditor, China (after our own Federal Reserve) who has been a net seller of US government debt for some time now. And where will the world go to find another dependable asset to hold as a store of value?

Triffin's endgame is simple. A rapid diversification of reserves out of the dollar by foreign central banks. This diversification out of the dollar is only possible given a viable alternative. More and more nations are agreeing to unilateral trade agreements settled in their individual currencies. With each new agreement, global demand for the dollar wanes. It is no coincidence that QE1 coincided with China and the rest of the world backing off demand for US treasury debt. The amounts of QE2 and QE3 match perfectly (or close enough for government work) with US trade deficits from 2009 to today. Given the US Government's seemingly permanent addiction to "free" foreign goods, the trade deficit appears to be irreversible. The extreme danger for those of us in the United States, holding assets denominated in US dollars, is that the Fed is actively creating base money to feed the addiction. As the monetary base grows, the value of existing US dollar denominated assets and credit is devalued. One way to protect against this debasement of your savings is to do as the central banks do – acquire and hold physical gold bullion.

The blueprint for this alternative has been in plain sight since the late 1990's, and if you watch what central banks do – not what they say – you can benefit.

For the first time in FOUR DECADES, global central banks have become net buyers of gold.This central bank demand has been driven by countries that previously had an insatiable appetite for US treasury debt – most notably China. After 40 years, the political and structural support for US dollar holdings abroad is slipping away. Foreign central banks know that the only way to protect their reserves (and defend the value of their home currency), is by holding gold. Their preparations are well under way.

Just as central banks are increasing their gold purchases, private citizens also are exercising their right to diversify their own private reserves. But given the still infinitesimal rates of gold ownership (1% tops most estimates) there is a long way to go. Why shouldn't the average person do what the big boys are doing? Diversifying out of the dollar, out of paper currencies and making sure their assets aren't someone else's liability seem prudent for everyone in times like there. Here at GBI, we see ourselves as a way for every investor to have the choice on how to save their stored labor. We want to make it as easy to buy and sell gold as it is to move money from your savings account to your checking account. We can all walk in the footsteps of the giants, as a Friend and mentor is apt to say.

As a bonus, if gold was to become the worlds foremost reserve asset, would that not finally solve good old Triffins dilemma? Wouldn't gold serving as the preferred global saving vehicle and fiat continuing to serve as the worlds spending vehicle finally break the natural tension Triffin has so aptly illuminated for us? Perhaps, but given golds stable supply and other unique features (see our next essay titled "Forget Supply and Demand, it's all Stock to Flow."), it would by necessity be at a much higher price to function in that reserve role. Some estimates put that potential price into the many tens of thousands of dollars, and given a monetary and fiscal path that seems to be following Triffin's fateful trajectory, how could any price be ruled out?

"There are two fundamental problems with this argument. The dollar is not the world's sole reserve currency, and the dollar is no longer pegged to good. The dollar is free floating, and euros and yen and increasingly the yuan are alternatives. Consequently the Triffin dilemma no longer applies"

"There are two fundamental problems with this argument. The dollar is not the world's sole reserve currency, and the dollar is no longer pegged to [gold]. The dollar is free floating, and euros and yen and increasingly the yuan are alternatives. Consequently the Triffin dilemma no longer applies"

True. I would add though that the original piece was filled with good background information; it just doesn't support the theory advanced.

Our problems are political, not structural. We are using unsustainable monetary tricks like quantitative expansion to cover the gap created by fiscal irresponsibility and a fiercely anti-growth agenda. The fact that other places are doing even worse provides temporary cover for the relatively value of our currency, but does not offset our declining prosperity.

The IMF’s forecasters are terribly worried about global growth – its new report not only contains further downward revisions to global growth forecasts, but talks of an alarming risk of a deeper slump, rising uncertainty, and so on.

Its latest World Economic Outlook features a special box, co-authored by chief economist Olivier Blanchard himself, which notes that “activity has disappointed in a number of economies undertaking fiscal consolidation”. It then examines the key assumption — ie, the fiscal multipler — used for estimating the effect of fiscal consolidation (aka austerity, debt retrenchment etc) upon aggregate output (aka GDP):

The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.

So… why did the IMF (among others) get it so wrong on the fiscal multiplier?

Antonio Fatás, an economics professor at INSEAD, has a theory. In the early 2000s Fatás and various other economists published papers considering the fiscal multiplier and concluding it was somewhere in the range of 1 to 1.5. More papers were published, including one co-authored by Blanchard. Fatás believes that, while some papers which “used events such as wars” tended to find multipliers of <1, the consensus was broadly around the multiplier being about 1 or a little higher.

And then, somehow, everything went wrong, writes Fatás:

The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.

So… why did the IMF (among others) get it so wrong on the fiscal multiplier?

Antonio Fatás, an economics professor at INSEAD, has a theory. In the early 2000s Fatás and various other economists published papers considering the fiscal multiplier and concluding it was somewhere in the range of 1 to 1.5. More papers were published, including one co-authored by Blanchard. Fatás believes that, while some papers which “used events such as wars” tended to find multipliers of <1, the consensus was broadly around the multiplier being about 1 or a little higher.

And then, somehow, everything went wrong, writes Fatás:

But these new (and old) academic results have simply be displaced by the ideological debate that followed the fiscal policy stimulus of the 2008-2009 period, which somehow led to the conclusion that those policies did not work and that what we now needed was more austerity. And when over the last two years we forecasted GDP growth rates in the face of coordinated austerity by many governments we somehow forgot to consider that multipliers can be large.

Fatas may well be right to say that the consensus was for a 1 or >1 fiscal multiplier, but the Blanchard paper he cites, which was first published in 1998 and co-authored with Roberto Perotti, is a little more ambivalent. It says, for example, that there is no consistent evidence for the Keynesian view that the tax multiplier is smaller than the fiscal multiplier. And more interestingly, the paper points out that the size of both tax or fiscal multipliers vary widely if one removes a single decade between 1960 and 1997. Depending which decade is removed, the result can be quite different:

<tax_fiscal_multiplier_blanchard-272x249.png>

The IMF special box on multiplier miscalculations notes that “earlier analysis by the IMF staff suggests that, on average, fiscal multipliers were near 0.5 in advanced economies during the three decades leading up to 2009″. That may be true too, but the uncertainty indicated by Blanchard’s own paper above suggests that assumptions about the multiplier are hardly safe.

The IMF says more work is warranted to examine the causes of this failure of multiplier assumptions. Perhaps monetary policy at the zero bound has some effect? Maybe it’s commodities prices? Who knows. But assumptions of a fiscal multiplier below 1 seem to be misplaced, at least right now. And the IMF is urging that countries who have ‘room to maneuvre’ such as the UK, France and the Netherlands, should “smooth their planned adjustment over 2013 and beyond” if growth falls significantly below the IMF’s increasingly gloomy forecasts.

In a new Focal Point, Project Syndicate contributors assess the global economy's future. Commentaries include Joseph Stiglitz on why the US and EU are relying excessively on their central banks, Daniel Gros on why government spending won't help countries recover, Martin Feldstein on the return of inflation, Kenneth Rogoff on the future of interest rates, and Jeffrey Frankel on the next black swan event.

MALIBU, Calif. — High above the cliff tops and the beach bars, up a winding mountain road, in a borrowed house on someone else’s ranch, an unusual criminal is waiting for his fate.

Mr. von NotHaus was convicted of using precious metals to back a currency he called the Liberty Dollar, which he says was “a private voluntary currency” for those conducting business outside the government’s purview.

His name is Bernard von NotHaus, and he is a professed “monetary architect” and a maker of custom coins found guilty last spring of counterfeiting charges for minting and distributing a form of private money called the Liberty Dollar. Described by some as “the Rosa Parks of the constitutional currency movement,” Mr. von NotHaus managed over the last decade to get more than 60 million real dollars’ worth of his precious metal-backed currency into circulation across the country — so much, and with such deep penetration, that the prosecutor overseeing his case accused him of “domestic terrorism” for using them to undermine the government.

Of course, if you ask him what caused him to be living here in exile, waiting with the rabbits for his sentence to be rendered, he will give a different account of what occurred.

“This is the United States government,” he said in an interview last week. “It’s got all the guns, all the surveillance, all the tanks, it has nuclear weapons, and it’s worried about some ex-surfer guy making his own money? Give me a break!”

The story of Mr. von NotHaus, from his beginnings as a hippie, can sound at times as if Ken Kesey had been paid in marijuana to write a script on spec for Representative Ron Paul. At 68, Mr. von NotHaus faces more than 20 years in prison for his crimes, and this decisive chapter of his tale has come, coincidentally, at a moment when his obsessions of 40 years — monetary policy, dollar depreciation and the Federal Reserve Bank — have finally found their place in the national discourse.

A native of Kansas City, Mr. von NotHaus first became enticed by making money while living with his companion, Talena Presley, without a car or electric power in a commune of like-minded dropouts in a nameless village on the Big Island in Hawaii. It was 1974, and Mr. von NotHaus, 30 and ignorant of economics, experienced “an epiphany,” he said, which resulted in the writing of a 20-page financial manifesto titled “To Know Value.”

In it he described his conviction that money has a moral aspect and that any loss in its value will cause a corresponding loss in social and political values. It was only three years after President Richard M. Nixon had removed the country from the gold standard, and Mr. von NotHaus, a gold enthusiast, began buying gold from local jewelers and selling it to his friends.

One day, he recalled, “we were all sitting around thinking, ‘Wow, we ought to do something with this gold.’ And I said: ‘Yeah, we could make coins. People love coins. We could have our own money!’ ”

Within a year, he had established the Royal Hawaiian Mint, a private — not royal — producer of collectible coins. Hitchhiking to a library in the county seat of Hilo, he said, he looked up “minting” in the encyclopedia and soon was turning out gold and silver medallions with images of volcanos and the Kona Coast.

So went the better part of 20 years. Then came 1991, which saw the emergence of a successful local currency in Ithaca, N.Y., called the Ithaca Hour. The 1990s were a time of great ferment in the local-money world with activists and academics writing books and papers, like Judith Shelton’s “Money Meltdown.” Mr. von NotHaus, traveling with his sons, Random and Xtra, to adventuresome locations, like Machu Picchu, read these seminal works.

“I had been working on it since 1974,” he testified at his federal trial in North Carolina. “It was time to do something.”

The Constitution grants to Congress the power “to coin money” and to “regulate the Value thereof” — but it does not explicitly grant an exclusive right to do such things. There are legal-tender laws that regulate production of government currency and counterfeiting laws that prohibit things like “uttering” gold or silver coins “for use as current money.”

Mr. von NotHaus claims he never meant the Liberty Dollar to be used as legal tender. He says he created it as “a private voluntary currency” for those conducting business outside the government’s purview. His guiding metaphor is the relationship between the Postal Service and FedEx. “What happened in the FedEx model,” he testified, “is that they” — a private company offering services the government did not — “brought competition to the post office.”

To introduce the Liberty Dollar in 1998, Mr. von NotHaus moved from Hawaii to Evansville, Ind., where he joined forces with Jim Thomas, who for several years had been publishing a magazine called Media Bypass, whose pages were filled with conspiracy theories and interviews with militia members, even Timothy McVeigh.

Working from the magazine’s office, Mr. von NotHaus lived in a mobile home and promoted his nascent currency to “patriot groups” on Mr. Thomas’s mailing list while reaching an agreement with Sunshine Minting Inc., in Idaho, to produce the Liberty Dollar. His marketing scheme was simple: he drove around the country in a Cadillac trying to persuade local merchants like hair salons and restaurants to use his coins and to offer them as change to willing customers.

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Banks, of course, did not accept his money; however, to ensure that it found its way only into hands that wanted to use it, Mr. von NotHaus placed a toll-free number and a URL address on the currency he produced. If people mistakenly got hold of it, they could mail it back to Evansville and receive its equivalent in actual dollar bills.

Now jump ahead to 2004. A detective in Asheville, N.C., learned one day that a client of a credit union had to tried to pass a “fake coin” at one its local branches. An investigation determined that some business acquaintances of Mr. von NotHaus were, court papers say, allied with the sovereign citizens’ movement, an antigovernment group.

Federal agents infiltrated the Liberty Dollar outfit as well as its educational arm, Liberty Dollar University.

In 2006, with millions of the coins in circulation in more than 80 cities, the United States Mint sent Mr. von NotHaus a letter advising that the use of his currency “as circulating money” was a federal crime.

He ignored this advice,and in 2007, federal agents raided the offices in Evansville, seizing, among other things, copper dollars embossed with the image of Mr. Paul.

Two years later, Mr. von NotHaus was arrested on fraud and counterfeiting charges, accused of having used the Liberty Dollar’s parent corporation — Norfed, the National Organization for Repeal of the Federal Reserve — to mount a conspiracy against the United States.

At his federal trial, witnesses testified to the Liberty Dollar’s criminal similitude to standard American coins. They said his coins included images of Lady Liberty and cheekily reversed “In God We Trust” to “Trust in God.” Then again, his coins were made of real gold and silver, as American coins are not, and came in different sizes and unusual denominations of $10 and $20.

In his own defense, Mr. von NotHaus testified about a “philanthropic mission” to combat devaluation with a currency based on precious metals and asserted that he was not involved in “a radical armed offense against the government or their money.”

It was, of course, to no avail; and in 2011, a jury found him guilty after a 90-minute deliberation.

These days, Mr. von NotHaus paces shoeless in a mansion, in the hills above the ocean, that was lent to him by a friend. His sentencing has yet to be scheduled, and this leaves time for reflection. He feeds the hummingbirds outside his window. He reads books on fiat currency. He is even writing a book — on the gold standard, of course.

“The thing that fires me up the most,” he will say, “is this is what happens: When money goes bad, people go crazy. Do you know why? Because they can’t exist without value. Value is intrinsic in man.”

WHATEVER happens on Election Day, Americans will keep asking the same question: When will this economy get better?

In many ways, the answer won’t depend on who wins on Tuesday. Anyone who says otherwise is overstating the power of the American president. But if the president doesn’t have the power to fix things, who does?

It’s not the Federal Reserve. The Fed has been injecting more and more capital into the economy because — at least in theory — capital fuels capitalism. And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations. Billions in capital is also sitting inert and uninvested at private equity funds.

Capitalists seem almost uninterested in capitalism, even as entrepreneurs eager to start companies find that they can’t get financing. Businesses and investors sound like the Ancient Mariner, who complained of “Water, water everywhere — nor any drop to drink.”

It’s a paradox, and at its nexus is what I’ll call the Doctrine of New Finance, which is taught with increasingly religious zeal by economists, and at times even by business professors like me who have failed to challenge it. This doctrine embraces measures of profitability that guide capitalists away from investments that can create real economic growth.

Executives and investors might finance three types of innovations with their capital. I’ll call the first type “empowering” innovations. These transform complicated and costly products available to a few into simpler, cheaper products available to the many.

The Ford Model T was an empowering innovation, as was the Sony transistor radio. So were the personal computers of I.B.M. and Compaq and online trading at Schwab. A more recent example is cloud computing. It transformed information technology that was previously accessible only to big companies into something that even small companies could afford.

Empowering innovations create jobs, because they require more and more people who can build, distribute, sell and service these products. Empowering investments also use capital — to expand capacity and to finance receivables and inventory.

The second type are “sustaining” innovations. These replace old products with new models. For example, the Toyota Prius hybrid is a marvelous product. But it’s not as if every time Toyota sells a Prius, the same customer also buys a Camry. There is a zero-sum aspect to sustaining innovations: They replace yesterday’s products with today’s products and create few jobs. They keep our economy vibrant — and, in dollars, they account for the most innovation. But they have a neutral effect on economic activity and on capital.The third type are “efficiency” innovations. These reduce the cost of making and distributing existing products and services. Examples are minimills in steel and Geico in online insurance underwriting. Taken together in an industry, such innovations almost always reduce the net number of jobs, because they streamline processes. But they also preserve many of the remaining jobs — because without them entire companies and industries would disappear in competition against companies abroad that have innovated more efficiently.

Efficiency innovations also emancipate capital. Without them, much of an economy’s capital is held captive on balance sheets, with no way to redeploy it as fuel for new, empowering innovations. For example, Toyota’s just-in-time production system is an efficiency innovation, letting manufacturers operate with much less capital invested in inventory.

INDUSTRIES typically transition through these three types of innovations. By illustration, the early mainframe computers were so expensive and complicated that only big companies could own and use them. But personal computers were simple and affordable, empowering many more people.

Companies like I.B.M. and Hewlett-Packard had to hire hundreds of thousands of people to make and sell PC’s. These companies then designed and made better computers — sustaining innovations — that inspired us to keep buying newer and better products. Finally, companies like Dell made the industry much more efficient. This reduced net employment within the industry, but freed capital that had been used in the supply chain.

Ideally, the three innovations operate in a recurring circle. Empowering innovations are essential for growth because they create new consumption. As long as empowering innovations create more jobs than efficiency innovations eliminate, and as long as the capital that efficiency innovations liberate is invested back into empowering innovations, we keep recessions at bay. The dials on these three innovations are sensitive. But when they are set correctly, the economy is a magnificent machine.

For significant periods in the last 150 years, America’s economy has operated this way. In the seven recoveries from recession between 1948 and 1981, according to the McKinsey Global Institute, the economy returned to its prerecession employment peak in about six months, like clockwork — as if a spray of economic WD-40 had reset the balance on the three types of innovation, prompting a recovery.

In the last three recoveries, however, America’s economic engine has emitted sounds we’d never heard before. The 1990 recovery took 15 months, not the typical six, to reach the prerecession peaks of economic performance. After the 2001 recession, it took 39 months to get out of the valley. And now our machine has been grinding for 60 months, trying to hit its prerecession levels — and it’s not clear whether, when or how we’re going to get there. The economic machine is out of balance and losing its horsepower. But why?

The answer is that efficiency innovations are liberating capital, and in the United States this capital is being reinvested into still more efficiency innovations. In contrast, America is generating many fewer empowering innovations than in the past. We need to reset the balance between empowering and efficiency innovations.

The Doctrine of New Finance helped create this situation. The Republican intellectual George F. Gilder taught us that we should husband resources that are scarce and costly, but can waste resources that are abundant and cheap. When the doctrine emerged in stages between the 1930s and the ‘50s, capital was relatively scarce in our economy. So we taught our students how to magnify every dollar put into a company, to get the most revenue and profit per dollar of capital deployed. To measure the efficiency of doing this, we redefined profit not as dollars, yen or renminbi, but as ratios like RONA (return on net assets), ROCE (return on capital employed) and I.R.R. (internal rate of return).Before these new measures, executives and investors used crude concepts like “tons of cash” to describe profitability. The new measures are fractions and give executives more options: They can innovate to add to the numerator of the RONA ratio, but they can also drive down the denominator by driving assets off the balance sheet — through outsourcing. Both routes drive up RONA and ROCE.

Similarly, I.R.R. gives investors more options. It goes up when the time horizon is short. So instead of investing in empowering innovations that pay off in five to eight years, investors can find higher internal rates of return by investing exclusively in quick wins in sustaining and efficiency innovations.

In a way, this mirrors the microeconomic paradox explored in my book “The Innovator’s Dilemma,” which shows how successful companies can fail by making the “right” decisions in the wrong situations. America today is in a macroeconomic paradox that we might call the capitalist’s dilemma. Executives, investors and analysts are doing what is right, from their perspective and according to what they’ve been taught. Those doctrines were appropriate to the circumstances when first articulated — when capital was scarce.

But we’ve never taught our apprentices that when capital is abundant and certain new skills are scarce, the same rules are the wrong rules. Continuing to measure the efficiency of capital prevents investment in empowering innovations that would create the new growth we need because it would drive down their RONA, ROCE and I.R.R.It’s as if our leaders in Washington, all highly credentialed, are standing on a beach holding their fire hoses full open, pouring more capital into an ocean of capital. We are trying to solve the wrong problem.

Our approach to higher education is exacerbating our problems. Efficiency innovations often add workers with yesterday’s skills to the ranks of the unemployed. Empowering innovations, in turn, often change the nature of jobs — creating jobs that can’t be filled.

Today, the educational skills necessary to start companies that focus on empowering innovations are scarce. Yet our leaders are wasting education by shoveling out billions in Pell Grants and subsidized loans to students who graduate with skills and majors that employers cannot use.Is there a solution? It’s complicated, but I offer three ideas to seed a productive discussion:

• CHANGE THE METRICS We can use capital with abandon now, because it’s abundant and cheap. But we can no longer waste education, subsidizing it in fields that offer few jobs. Optimizing return on capital will generate less growth than optimizing return on education.• CHANGE CAPITAL-GAINS TAX RATES Today, tax rates on personal income are progressive — they climb as we make more money. In contrast, there are only two tax rates on investment income. Income from investments that we hold for less than a year is taxed like personal income. But if we hold an investment for one day longer than 365, it is generally taxed at no more than 15 percent.

We should instead make capital gains regressive over time, based upon how long the capital is invested in a company. Taxes on short-term investments should continue to be taxed at personal income rates. But the rate should be reduced the longer the investment is held — so that, for example, tax rates on investments held for five years might be zero — and rates on investments held for eight years might be negative.

Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue. So the near-term impact on the budget will be minimal. But over the longer term, this policy change should have a positive impact on the federal deficit, from taxes paid by companies and their employees that make empowering innovations.

• CHANGE THE POLITICS The major political parties are both wrong when it comes to taxing and distributing to the middle class the capital of the wealthiest 1 percent. It’s true that some of the richest Americans have been making money with money — investing in efficiency innovations rather than investing to create jobs. They are doing what their professors taught them to do, but times have changed.If the I.R.S. taxes their wealth away and distributes it to everyone else, it still won’t help the economy. Without empowering products and services in our economy, most of this redistribution will be spent buying sustaining innovations — replacing consumption with consumption. We must give the wealthiest an incentive to invest for the long term. This can create growth.

Granted, mine is a simple model, and we face complicated problems. But I hope it helps us and our leaders understand that policies that were once right are now wrong, and that counterintuitive measures might actually work to turn our economy around.==================A friend of the Austrian school comments:

It's easy to agree with some of his points and a few of his conclusions. Surely, for example, no politician or political party is going to be able to set economic things right in the next few years. And it's always desirable to make some changes in tax policy. But beyond that, though, this piece offers up some wildly wrong ideas -- ideas that lead to bad conclusions and terrible "advice" to both politicians and business people.

Perhaps the most fundamentally wrong point is contained in this sentence: "The Fed has been injecting more and more capital into the economy because — at least in theory — capital fuels capitalism." This author seems to completely misunderstand the nature of both money and capital. And this is darned important if you are trying to understand a market economy.

The Fed cannot create any capital at all. None. The Fed creates money. "Capital" includes all the goods that an entrepreneur might want to acquire with money: goods and services that facilitate his production of additional goods. The Fed can print money all it wants, but that only increases the monetary spending against the existing supply of available goods.

And then Christensen goes on to say "And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations. Billions in capital is also sitting inert and uninvested at private equity funds."

The very best thing we can say about such a statement is that it represents careless thinking. The simple fact is that every single US dollar created by the Fed or the banking system must be held by somebody. Once they are created, those dollars must appear in the aggregate bank balance data until they are destroyed. The existence of "billions sitting idle," in other words, is a direct consequence of the Fed's policy and there is nothing that will change that short of the Fed removing money from the economy.

Consider, for example, that if a large holder of dollars decides to invest his money in something, anything -- those dollars will simply be transferred to another person's bank balance. When somebody like Mr. Christensen totals up the aggregate money balances, the result will be exactly the same as before the investment. Mr. Christensen will still be worried about the magnitude of "idle balances."

These fundamental errors in thinking lead toward the grievously bad ideas expressed later in this article. Capital is no more plentiful in our contemporary environment than it ever was. And there is no problem with the way business people or investors calculate profits. The problem with our economy is precisely the fact that people believe "capital" is more plentiful than it is. The Fed's distortions of interest rates and its creation of ever growing dollar balances causes bad investments and distorted market prices across the board. As a consequence, we have severely damaged the market's ability to direct both human effort and capital toward those economic sectors and projects that will deliver the best value to consumers now and in the long run.

The solution is simple: we need to remove as many government interventions as is politically possible. It is particularly important to stop the Fed's catastrophic inflationary policies. The price system, given a more nearly free market environment, will solve all of the problems that Christensen is lamenting, and then some. Based on this article, it appears to me that Christensen is just another misguided "statist" -- a person who thinks that every problem he identifies must require further central planning. Now, it seems, he wants to send out an instruction book to entrepreneurs explaining the nature of investments with guidelines regarding what is scarce and what is not! The man should have a seat within the Politburo.

Every one of Hussman’s funds proves the author’s point. They hold large amounts of cash. They invest mainly in companies that sell sustaining innovations like Radio Shack or health care companies like Wellpoint. Hussman judges their effectiveness on the basis of IRR, yield and other statistics. Each fund holds 30-34% of its assets in cash or cash equivalents. His Strategic Total Return Fund holds 54% of its assets in US Treasury securities and 30% of its assets in cash or money market funds.

Tom, you have become hung up on his comment about capital. As a result, you have gotten sidetracked on an issue that is immaterial to the author’s hypothesis. Christensen says that capital is abundant, but is being misallocated due to an inefficient educational system that subsidizes the wrong skill sets, a tax code that encourages this misallocation, and modern business theory that encourages companies to invest the largest percentage of their capital into sustaining and efficiency innovations because those investments produce the best results on the income statement. He argues that unless the US is able to reallocate capital to empowering innovations, its economy will never recover. He is talking about the use of capital. You cannot get beyond the amount of capital.

Also, Tom, you are thinking secondary securities markets. Christensen is thinking about the primary securities markets; ie., private equity in start-ups, IPO’s, direct bank lending, venture capital. If your hypothesis is true and the current policy has prompted the holders of capital to use it to bid up the prices of securities in the secondary markets, then your observation also proves Christensen’s hypothesis. Capital is abundant, but it is being misallocated.

From my own recent experience, I can say that the prices of securities in the primary markets are attractively low. For example, I recently purchased preferred shares of a small private Israeli start-up that has developed a chip that can make any device talk to any other device regardless of the network or regardless of the protocol. This has the potential to be an empowering device because it will enable any smartphone or tablet user to be able to use any network. The price per share was dirt cheap and the cost of the investment was the cost of the bank wire. But why did I have to go to Israel to find this venture? And why has this and other start-up companies encountered so many problems accessing capital that it would consider me? I think that Christensen provides a good starting point for such discussions. And that is all his column was intended to do.

R.======================My point, R., is that the pricing system has been distorted by Fed actions. Without all these interventions, surely the price mechanism will be more efficient in allocating capital than any other process. There is no way to figure these things out on a centralized basis. Why are capital markets causing the problems you describe? Isn't it quite possible that it has something to do with a Fed that thinks short term rates should be zero, and that it should spend trillions in an attempt to manipulate longer term rates?

If I am giving too much attention to this issue, you are giving it too little. Market interventions have consequences. If everybody is being stupid, there has to be a reason for it -- markets are distorted and the resulting economy is dysfunctional.

It's the price mechanism that coordinates individual and independent economic decisions. Decentralized decision making is the only way for a large economy to work, and Christensen's thesis is valid only if individual entrepreneurs and business people find the ideas to be helpful.

Crafty, That is a good discussion on all 3 sides. Most simply, we need to end the war against starting and growing companies.

I only agree partly with Prof. Christensen's idea of making more tiers for time length held on capital gains taxation and for different reasons. My reason would be because of the declining value of each dollar of return.

Tweaking the system with a goal of favoring one type of innovation over another is not simplicity.

His calls for more education focus is interesting, a topic in itself. Mostly the solution is just changing the mindset against businesses and enterprises, addressing simple competitiveness issues that we keep getting wrong. If we want investment, employment and innovation, why do we slap 50,000 new regulations down in the last 45 months. Don't have the highest corporate taxes in the world with capital gains tax rates scheduled to triple. Don't place new burdens on employers like Obamacare, new medical device taxes, war against energy/ new war against fracking coming, etc. These are anti-growth, anti startup measures.

When the Pilgrims landed in 1620, they established a system of communal property. Within three years they had scrapped it, instituting private property instead. Hoover media fellow Tom Bethell tells the story.

There are three configurations of property rights: state, communal, and private property. Within a family, many goods are in effect communally owned. But when the number of communal members exceeds normal family size, as happens in tribes and communes, serious and intractable problems arise. It becomes costly to police the activities of the members, all of whom are entitled to their share of the total product of the community, whether they work or not. This is the free-rider problem, and it is the most important institutional reason tribes and communes cannot rise above subsistence level (except in special circumstances, such as monasteries).

State ownership, as we saw in the Soviet Union, has its own problems. For these reasons, private property is the only institutional arrangement that will permit a society to be productive, peaceful, free, and just. The free-rider problem was plainly demonstrated at Plymouth Colony in 1620, when the Mayflower arrived in the New World. Contrary to the Pilgrims’ wishes, their initial ownership arrangement was communal property.

Desiring to practice their religion as they wished, the Pilgrims emigrated in 1609 from England to Holland, then the only country in Europe that permitted freedom of worship. They found life in Holland to be in many respects satisfactory. But war with Spain was a constant threat, and the Pilgrims did not want their children to grow up Dutch. They longed to start afresh in “those vast and unpeopled countries of America,” as William Bradford would later write in his history, Of Plymouth Plantation. There, they could look forward to propagating and advancing “the gospel of the kingdom of Christ.”

Thirty years old when he arrived in the New World, Bradford became the second governor of Plymouth (the first died within weeks of the Mayflower’s arrival) and the most important figure in the early years of the colony. He recorded in his history the key passage on property relations in Plymouth and the way in which they were changed. His is the only surviving account of these matters.

DRIVING A HARD BARGAIN

The Pilgrims knew about the early disasters at Jamestown, but the more adventurous among them were willing to hazard the Atlantic anyway. First, however, they sent two emissaries, John Carver and Robert Cushman, from Leyden to London to seek permission to found a plantation. This was granted, but finding investors was a problem. Eventually Carver and Cushman found an investment syndicate headed by a London ironmonger named Thomas Weston. Weston and his fifty-odd investors were taking a big risk in putting up the equivalent of hundreds of thousands of dollars in today’s money. The big losses in Jamestown had scared off most “venture capital” in London.

Those waiting for news in Leyden were concerned that their agents in London would, in their eagerness to find investors, agree to unfavorable terms. Carver and Cushman were admonished “not to exceed the bounds of your commission.” They were particularly enjoined not to “entangle yourselves and us in any such unreasonable [conditions as that] the merchants should have the half of men’s houses and lands at the dividend.”

Eventually, however, Carver and Cushman did accept terms stipulating that at the end of seven years everything would be divided equally between investors and colonists. Some historians claim that those who came over on the Mayflower were exploited by capitalists. In a sense, they were. But of course they came voluntarily.

The colonists hoped that the houses they built would be exempt from the division of wealth at the end of seven years; in addition, they sought two days a week in which to work on their own “particular” plots (much as collective farmers later had their own private plots in the Soviet Union). The Pilgrims would thereby avoid servitude. But the investors refused to allow these loopholes, undoubtedly worried that if the Pilgrims—three thousand miles away and beyond the reach of supervision—owned their own houses and plots, the investors would find it difficult to collect their due. How could they be sure that the faraway colonists would spend their days working for the company if they were allowed to become private owners? With such an arrangement, rational colonists would work little on “company time,” reserving their best efforts for their own gardens and houses. Such private wealth would be exempt when the shareholders were paid off. Only by insisting that all accumulated wealth was to be “common wealth,” or placed in a common pool, could the investors feel reassured that the colonists would be working to benefit everyone, including themselves.

The investors unquestionably had profit in mind when they insisted on common property. The Pilgrims went along because they had little choice.

Those waiting in Leyden objected to this arrangement. If the Pilgrims were not permitted private dwellings, “the building of good and fair houses” would be discouraged, they wrote back to London. Robert Cushman was thus caught in a cross-fire between profit-seeking investors in London and his worried Leyden brethren, who accused him of “making conditions fitter for thieves and bondslaves than honest men.”

Cushman responded with an artful case for common ownership: “Our purpose is to build for the present such houses as, if need be, we may with little grief set afire and run away by the light. Our riches shall not be in pomp but in strength; if God send us riches we will employ them to provide more men, ships, munition, etc.”

Common ownership would also “foster communion” among the Pilgrims, he thought (wrongly). Having held discussions with the investors, who seem to have been unyielding, Cushman wanted to close the deal. So he tried to persuade his brethren not to worry about the property arrangements. Those still in Leyden remained unconvinced and unreconciled to the terms, but there was little they could do. Many had already sold their property in Holland and so had no bargaining power.

It is worth emphasizing all this because it is sometimes said that the Pilgrims in Massachusetts established a colony with common property in emulation of the early Christians. Not so. It is true that their agent Cushman used arguments that were calculated to appeal to Christians—in particular warning them against the perils of prosperity—in order to justify his acceptance of unpopular terms. No doubt he felt that a bad deal was better than none. But the investors themselves unquestionably had profit in mind when they insisted on common property. The Pilgrims went along because they had little choice.

The Pilgrims may have been “exploited,” but a greater source of hardship was the harsh environment of the North American continent. This needs to be stressed, given the tendency to regard the wealth of the United States as a product of “abundant natural resources” and the equally erroneous association of the Mayflower and those who arrived in it with the idea of privilege.

THE COMMUNAL EXPERIMENT

The Mayflower arrived at Cape Cod in November 1620 with 101 people on board. About half of them died within the first few months, probably of scurvy, pneumonia, or malnutrition. It is not easy for us to grasp the hardships that the first settlers in this country experienced, even in New England, where the native American Indians were relatively friendly.

By the spring of 1623, the population of Plymouth can have been no larger than 150. But the colony was still barely able to feed itself, and little cargo was returning for the investors in England. On one occasion newcomers found that there was no bread at all, only fish or a piece of lobster and water. “So they began to think how they might raise as much corn as they could, and obtain a better crop than they had done, that they might not still thus languish in misery,” Bradford wrote in his key passage on property.

Having tried what Bradford called the “common course and condition”—the communal stewardship of the land demanded of them by their investors—Bradford reports that the community was afflicted by an unwillingness to work, by confusion and discontent, by a loss of mutual respect, and by a prevailing sense of slavery and injustice. And this among “godly and sober men.” In short, the experiment was a failure that was endangering the health of the colony.

Historian George Langdon argues that the condition of early Plymouth was not “communism” but “an extreme form of exploitative capitalism in which all the fruits of men’s labor were shipped across the seas.” In this he echoes Samuel Eliot Morison, who claims that “it was not communism . . . but a very degrading and onerous slavery to the English capitalists that was somewhat softened.” Notice that this does not agree with the dissension that Bradford reports, however. It was between the colonists themselves that the conflicts arose, not between the colonists and the investors in London. Morison and Langdon conflate two separate problems. On the one hand, it is true that the colonists did feel “exploited” by the investors because they were eventually expected to surrender to them an undue portion of the wealth they were trying to create. It is as though they felt that they were being “taxed” too highly by their investors—at a 50 percent rate, in fact.

But there was another problem, separate from the “tax” burden. Bradford’s comments make it clear that common ownership demoralized the community far more than the tax. It was not Pilgrims laboring for investors that caused so much distress but Pilgrims laboring for other Pilgrims. Common property gave rise to internecine conflicts that were much more serious than the transatlantic ones. The industrious (in Plymouth) were forced to subsidize the slackers (in Plymouth). The strong “had no more in division of victuals and clothes” than the weak. The older men felt it disrespectful to be “equalized in labours” with the younger men.

This suggests that a form of communism was practiced at Plymouth in 1621 and 1622. No doubt this equalization of tasks was thought (at first) the only fair way to solve the problem of who should do what work in a community where there was to be no individual property: If everyone were to end up with an equal share of the property at the end of seven years, everyone should presumably do the same work throughout those seven years. The problem that inevitably arose was the formidable one of policing this division of labor: How to deal with those who did not pull their weight?

The Pilgrims had encountered the free-rider problem. Under the arrangement of communal property one might reasonably suspect that any additional effort might merely substitute for the lack of industry of others. And these “others” might well be able-bodied, too, but content to take advantage of the communal ownership by contributing less than their fair share. As we shall see, it is difficult to solve this problem without dividing property into individual or family-sized units. And this was the course of action that William Bradford wisely took.

PROPERTY IS PRIVATIZED

Bradford’s history of the colony records the decision:

At length, after much debate of things, the Governor (with the advice of the chiefest amongst them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves; in all other things to go in the general way as before. And so assigned to every family a parcel of land, according to the proportion of their number.

So the land they worked was converted into private property, which brought “very good success.” The colonists immediately became responsible for their own actions (and those of their immediate families), not for the actions of the whole community. Bradford also suggests in his history that more than land was privatized.

The system became self-policing. Knowing that the fruits of his labor would benefit his own family and dependents, the head of each household was given an incentive to work harder. He could know that his additional efforts would help specific people who depended on him. In short, the division of property established a proportion or “ratio” between act and consequence. Human action is deprived of rationality without it, and work will decline sharply as a result.

Under communal land stewardship, Bradford reports, the community was afflicted by an unwillingness to work, by confusion and discontent, by a loss of mutual respect, and by a prevailing sense of slavery and injustice.

William Bradford died in 1657, having been reelected governor nearly every year. Among his books, according to the inventory of his estate, was Jean Bodin’s Six Books of a Commonweale, a work that criticized the utopianism of Plato’s Republic. In Plato’s ideal realm, private property would be abolished or curtailed and most inhabitants reduced to slavery, supervised by high-minded, ascetic guardians. Bodin said that communal property was “the mother of contention and discord” and that a commonwealth based on it would perish because “nothing can be public where nothing is private.”

Bradford felt that, in retrospect, his real-life experience of building a new society at Plymouth had confirmed Bodin’s judgment. Property in Plymouth was further privatized in the years ahead. The housing and later the cattle were assigned to separate families, and provision was made for the inheritance of wealth. The colony flourished. Plymouth Colony was absorbed into the Commonwealth of Massachusetts, and in the prosperous years that lay ahead, nothing more was heard of “the common course and condition.”

When I was younger, everyone knew that the New Deal had saved the US economy from the ravages of the Great Depression. Everyone knew that Keynes was right—look what had happened when Roosevelt implemented his ideas—the Great Depression ended! Eventually, everyone knew that story was false. The New Deal wasn't that big and the Great Depression didn't really end when the New Deal was implemented.

Now everyone knows that World War II ended the Great Depression. Of course, private consumption fell during WWII and the vaunted Keynesian multiplier seemed to only work for the defense industry. Someday, perhaps, people will understand that when a war takes over most of the industrial sector, you don't get much stimulus. And it's not hard to reduce unemployment when you force a huge chunk of the male working-age population into the army.

When the war ended, all the Keynesians predicted disaster and a horrible depression because of the cuts in government spending and men coming home from Europe and the Pacific. Well, when that didn't happen, people should have known that there isn't a simple relationship between government spending and prosperity. But somehow, people didn't learn that lesson.

It being Thomas Friedman of course there is the fascist public-private partnership horsefeathers nonsense, but the larger point here seems relevant to me:

It’s P.Q. and C.Q. as Much as I.Q.By THOMAS L. FRIEDMANPublished: January 29, 2013 340 Comments

President Obama’s first term was absorbed by dealing with the Great Recession. I hope that in his second term he’ll be able to devote more attention to the Great Inflection.

Dealing with the Great Recession was largely about “Yes We Can” — about government, about what we can and must do “together” to shore up the safety nets and institutions that undergird our society and economy. Obama’s Inaugural Address was a full-throated defense of that “public” side of the unique public-private partnership that makes America great. But, if we’re to sustain the kind of public institutions and safety nets that we’re used to, it will require a lot more growth by the private side (not just more taxes), a lot more entrepreneurship, a lot more start-ups and a lot more individual risk-taking — things the president rarely speaks about. And it will all have to happen in the context of the Great Inflection.

What do I mean by the Great Inflection? I mean something very big happened in the last decade. The world went from connected to hyperconnected in a way that is impacting every job, industry and school, but was largely disguised by post-9/11 and the Great Recession. In 2004, I wrote a book, called “The World Is Flat,” about how the world was getting digitally connected so more people could compete, connect and collaborate from anywhere. When I wrote that book, Facebook, Twitter, cloud computing, LinkedIn, 4G wireless, ultra-high-speed bandwidth, big data, Skype, system-on-a-chip (SOC) circuits, iPhones, iPods, iPads and cellphone apps didn’t exist, or were in their infancy.

Today, not only do all these things exist, but, in combination, they’ve taken us from connected to hyperconnected. Now, notes Craig Mundie, one of Microsoft’s top technologists, not just elites, but virtually everyone everywhere has, or will have soon, access to a hand-held computer/cellphone, which can be activated by voice or touch, connected via the cloud to infinite applications and storage, so they can work, invent, entertain, collaborate and learn for less money than ever before. Alas, though, every boss now also has cheaper, easier, faster access to more above-average software, automation, robotics, cheap labor and cheap genius than ever before. That means the old average is over. Everyone who wants a job now must demonstrate how they can add value better than the new alternatives.

When the world gets this hyperconnected, adds Mundie, the speed with which every job and industry changes also goes into hypermode. “In the old days,” he said, “it was assumed that your educational foundation would last your whole lifetime. That is no longer true.” Because of the way every industry — from health care to manufacturing to education — is now being transformed by cheap, fast, connected computing power, the skill required for every decent job is rising as is the necessity of lifelong learning. More and more things you know and tools you use “are being made obsolete faster,” added Mundie. It’s as if every aspect of our lives is now being driven by Moore’s Law. This is exacerbating our unemployment problem.

In their terrific book, “Race Against the Machine: How the Digital Revolution Is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy,” Erik Brynjolfsson and Andrew McAfee of the Massachusetts Institute of Technology note that for the last two centuries it happened that productivity, median income and employment all tracked each other nicely. “So most economists have had this feeling that if you just boost productivity, the pie grows, and, in the long run, everything else takes care of itself,” explained Brynjolfsson in an interview. “But there is no economic law that says technological progress has to benefit everyone. It’s entirely possible for the pie to get bigger and some people to get a smaller slice.” Indeed, when the digital revolution gets so cheap, fast, connected and ubiquitous you see this in three ways, Brynjolfsson added: those with more education start to earn much more than those without it, those with the capital to buy and operate machines earn much more than those who can just offer their labor, and those with superstar skills, who can reach global markets, earn much more than those with just slightly less talent.

Put it all together, he added, and you can understand, why the Great Recession took the biggest bite out of employment but is not the only thing affecting job loss today: why we have record productivity, wealth and innovation, yet median incomes are falling, inequality is rising and high unemployment remains persistent.

How to adapt? It will require more individual initiative. We know that it will be vital to have more of the “right” education than less, that you will need to develop skills that are complementary to technology rather than ones that can be easily replaced by it and that we need everyone to be innovating new products and services to employ the people who are being liberated from routine work by automation and software. The winners won’t just be those with more I.Q. It will also be those with more P.Q. (passion quotient) and C.Q. (curiosity quotient) to leverage all the new digital tools to not just find a job, but to invent one or reinvent one, and to not just learn but to relearn for a lifetime. Government can and must help, but the president needs to explain that this won’t just be an era of “Yes We Can.” It will also be an era of “Yes You Can” and “Yes You Must.”

Whenever I get ready to rip Friedman for his emptyness, I read closer that you already did: "the fascist public-private partnership horsefeathers nonsense".

Yes, he intermixes truth and insight in with his distortions to stay relevant.

The reason a growing economy with foundations in technological advancements does not help everyone is because we pay half the people to NOT participate in our productive economy and put ropes, weights and anchors on all the rest.

"if we’re to sustain the kind of public institutions and safety nets that we’re used to, it will require a lot more growth by the private side (not just more taxes), a lot more entrepreneurship, a lot more start-ups and a lot more individual risk-taking "

Every policy out of the current power structure is about thwarting all this and it has succeeded. As visionary Rush L famously and controversially said, I hope he fails (to kill off entrepreneurship, start-ups, individual risk-taking, and private sector growth).

"things the president rarely speaks about"

He spoke about it to Joe the Plumber. He said fuck you Joe. He said I'm going a different direction and I got bigger fish to fry. He said you are not my problem and you are not my voter.

It isn't that the President rarely speaks, it is that the President rarely listens. I continue my unrefuted contention that this Ivy-League President has not read a book on economics that was not about opposing and dismantling the world's most successful system.

"The winners won’t just be those with more I.Q. It will also be those with more P.Q. (passion quotient) and C.Q. (curiosity quotient) to leverage all the new digital tools to not just find a job, but to invent one or reinvent one, and to not just learn but to relearn for a lifetime."

This President is about taking down winners, not finding and motivating more of them. You can succeed if you want in spite of him and his government but the deck is stacked against you. It is mostly insiders only who can win now. To take private initiative you need to fight off 9 layers of government working against you and still have the time and resources left that Edison and Bell had to invent, reinvent, set up shop, mass produce, market and sell your goods. Those guys were few and far between enough. Today your first ten million need to all go toward lawyers, lobbyists and accountants, good luck paying enough software engineers to stay ahead of your foreign competition before revenues come in. Who has that kind of money? Far less than one percent of us.

This doesn't get solved by pressing Obama to do more. Friedman thinks Obama could change a couple words, just say yes you can, or whip inflation now, lol. Good f'ing grief. If he thinks America could stand to slant a little more toward private initiative, how about taking that unpopular NYT stand PRE-election?! (My frustrations are aimed at the author, not the poster. )

"what do you make of his point about a fundamental economic change due to "the great inflection"?"

Like GM says, Friedman from the old neighborhood sees very profound things in his own thinking and writing. The inflection point is where the curve begins to turn a different direction, where concavity changes sign. From or to where did it turn?

What is the fundamental economic change due to the great inflection?

He is saying (I think) that because of globalization, technological advancement and hyper connectedness that a few can get extremely wealthy (Bill Gates, Apple, Qualcomm, google, etc) because when you invent something you can sell it to a zillion people instead of a thousand like a local butcher or a million like a good regional supplier. The corollary is that the rest of us get left behind and for that we get no evidence.

The middle class did not get left behind in the last 2-3 expansions, that was false math and measurements exposed recently. If people around me get richer in a global market and I mow lawns, paint houses or remodel kitchens, then more people around me can better afford to do those things and pay well. It also means that if I want to follow them I can find niches and do apps that run on google, apple, microsoft or innovate with other product and service ideas that a richer world can now better afford to buy.

"In 2004, I wrote a book, called “The World Is Flat,” (Freidman said for the five thousandth time) about how the world was getting digitally connected so more people could compete, connect and collaborate from anywhere". - Nothing in that or his other random sentences about the world changing more quickly leads to his big conclusion: "This is exacerbating our unemployment problem."

Obama says the ATM caused unemployment too and it is complete bunk.

Freidman you blockhead (I reply with all due respect), the unemployment is caused by the policy war against business, investment, expansion and innovation that you seem to support and is caused by nothing else. Are things less connected, technologized or globalized in Singapore at 1.9% unemployment and at less than half the rate of taxation, with a culture that says you work instead of ride? These amazing developments help us to employ people; they don't keep us from employing people. Where in his empty logic string did he even think he made that case?

These super successful, hyper-connected companies, here it is 3M for example, turn down business opportunities everyday that don't meet their corporate requirements for expected IRR, internal rate or return, leaving millions to be made by others because the big guys can only think in billions. Again, I just don't follow how everything getting more productive leads to bad economic outcomes. It is our political, policy choices, stupid.

There is an emerging new middle class numbering in the billions in India, China and Brazil wanting to buy your products. You will need an eBay and Paypal account to sell there. That takes 10 minutes and costs nothing. Crafty's seminars the world over are a great example of connectness leading to business opportunities. When I started in export you needed telex, hundreds of dollars an hour for phone service, plus export licenses, letters of credit, sight drafts and translators. Good grief, it's not getting harder to make a living, there are just too many people taking from your income, and when did you NOT have to keep your skills up with the times to be considered a professional of any kind?

Doug:I get your point but at the same time I confess to having a similar notion to TF's e.g. when I read of outsourcing reading depositions to lawyers in India.

Global trade increases employment at both ends just like local trade does. Comparative advantage. As Rbt Bartley, former WSJ editor put it, it is both a) beneficial and b) inevitable. If you don't like a) see b). Examples, the traders of the exploring eras, Denmark, Netherlands etc. increased wealth. See Hong Kong. See Germany. West Germany I think used to be the leading exporter in the world. Why wasn't it East Germany with lower wagers? Germany even after absorbing the East is still the strongest economy in Europe. Dubai in the Middle East. The alternative I used to call the Albania plan. I forget the details, let's say a hundred years of closed borders and a dollar and per capita GDP the worst around. See North Korea, their not outsoursing jobs to China or anyone else and have no wealth. How to convince people who aren't convinced of this is another matter. Singapore, already mentioned, perfect example. They aren't lower wage than Vietnam, India, China or anyone around them, but they are a free trade port. 1.9% unemployment. Show me the exception, the free trade port that is losing out to cheap labor.

If you limit a study to one thing at a time, let's say hand stenographers or 8-track tape manufacturing, then maybe we lose. We do not lose with open trade in a dynamic economy, not with India, nor do they lose trading with us. It is by definition mutually beneficial on every consensual transaction.

I get all that, Ricardo's benefits of comparative advantage and all that. I get that it is inevitable too. I'm just noting that in the process a lot of people here in the US may wind up quite a bit worse because they now have to compete with low wage labor and/or high skill labor because previous barriers to entry have been smashed.

Forced to adapt in an open, dynamic economy, but not worse off. Actually worse off when artificially sheltered from real competition. It's not a fixed pie and someone else working does not take from yours/ours. Someone else working means one more potential customer, supplier or employer

When able minded people fail to adapt it is because we pay them not to. Then the problem is with that program, not the increased comnectedness.

Freidman showed no mstj, no graph and no inflectiom point. All fiction and cliche.

More competition equals lower prices for one's labor/services. Of course the low wage worker from elsewhere benefits, but exactly how does a lawyer who has to compete with Indian lawyers for reading depositions benefit? Yes the partners of the firm benefit, and to the extent that the cost to the clients decreases, they benefit, but my point at the moment is addressed to, for example, the young associates in the firm who have lost this work.

Yes, for the stagnant supplier who refuses to change, improve, expand.

"Of course the low wage worker from elsewhere benefits, but exactly how does a lawyer who has to compete with Indian lawyers for reading depositions benefit? Yes the partners of the firm benefit, and to the extent that the cost to the clients decreases, they benefit, but my point at the moment is addressed to, for example, the young associates in the firm who have lost this work."

I wrote that the able-minded people in a dynamic economy will adapt - and you bring me lawyers helping people sue and be sued as the test of that? (so many emoticons...) With sarcasm, how could they possibly change or grow in the face of low cost competition? They are only lawyers capable of one thing. Reminds me of the Michael Moore movie out of Flint Michigan where no one has done anything else but work (overpaid) for General Motors for four generations. There is nothing else they could do. (Especially if we pay them to do nothing else.)

How about put energy into something that has a bright future instead of dying one? If that part of their job wasn't going away today, it was going away tomorrow. I gave the example of 8 track tape manufacturers. Disruption was going to occur, what then? Move on, move forward, innovate. Use these new tools to YOUR advantage.

Let's say the young lawyers were getting $200 an hour for a task, reading the deposition, that can be done just as well by lawyers(?) not even in the room, in the country...

It is beyond my pay scale to write everyone's innovation by here are a few ideas. Let's start with acknowledging that they didn't deserve that money if they weren't adding value and were so easily replaced. They could do what other professionals have to do, sell the idea that their service is worth it, their knowledge and experience is unique and valuable.

Lawyer friends of mine have taken hot topics of the moment, asbestoes and mold defense are examples, they assembled the research, wrote the papers, set up the seminars across the country that other lawyers need to be up to speed, for a considerable fee I presume. A room full of paid seminar attendees pays more and provides more value than one lawyer taking one deposition.

Innovation in every industry is possible, or resources move elsewhere - to their most productive use.

Lawyers, like people, can do things other than law. (A worldwide martial arts operation comes to mind.) Back to the others, take the years of accumulated $200 shakedowns and invest in a new idea, hire people, build a product, offer a service that is in demand and can't be done just as well someone less qualified 8000 miles away.

I did not say (or mean to say) a dynamic economic has no dislocations in the short run. I said everyone is better off with the competition and with the dynamic aspect of it. For the lawyer, maybe he loses a low end task but gains more clients, bigger clients, from the increased success from Freidmanesque connectnedness running wild in other sectors.

Back to inevitable, what is the alternative to letting the low cost competitor compete and force the high lost provider to adapt and innovate. Legislate away the freedom of the client to transact a better deal and enable the high cost supplier to stagnate, to collect those fees another year? Then look at those protected economies putting up those barriers and tell me they are more prosperous with lower unemployment than the free zones I mentioned. They aren't.

Does it mean the people don't have to constantly innovate and sharpen their skills, change and improve their product or service in a dynamic situation, and constantly question and tweak their business plan to survive and prosper? No, it means precisely that they must, and that it is a very good thing.

(I'm enjoying this Crafty, but on vacation, won't be very timely in a back and forth.)

Politicians from both right and left could learn from the Nordic countries Feb 2nd 2013 |From the print edition

SMALLISH countries are often in the vanguard when it comes to reforming government. In the 1980s Britain was out in the lead, thanks to Thatcherism and privatisation. Tiny Singapore has long been a role model for many reformers. Now the Nordic countries are likely to assume a similar role.

That is partly because the four main Nordics—Sweden, Denmark, Norway and Finland—are doing rather well. If you had to be reborn anywhere in the world as a person with average talents and income, you would want to be a Viking. The Nordics cluster at the top of league tables of everything from economic competitiveness to social health to happiness. They have avoided both southern Europe’s economic sclerosis and America’s extreme inequality. Development theorists have taken to calling successful modernisation “getting to Denmark”. Meanwhile a region that was once synonymous with do-it-yourself furniture and Abba has even become a cultural haven, home to “The Killing”, Noma and “Angry Birds”.

In this sectionThe next supermodel Let them stay, let them in Tahrir squandered Shake ’em up, Mr Carney Guilty as charged

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Related topicsUnited States Norway Europe Denmark Nordic countries

As our special report this week explains, some of this is down to lucky timing: the Nordics cleverly managed to have their debt crisis in the 1990s. But the second reason why the Nordic model is in vogue is more interesting. To politicians around the world—especially in the debt-ridden West—they offer a blueprint of how to reform the public sector, making the state far more efficient and responsive.

From Pippi Longstocking to private schools

The idea of lean Nordic government will come as a shock both to French leftists who dream of socialist Scandinavia and to American conservatives who fear that Barack Obama is bent on “Swedenisation”. They are out of date. In the 1970s and 1980s the Nordics were indeed tax-and-spend countries. Sweden’s public spending reached 67% of GDP in 1993. Astrid Lindgren, the inventor of Pippi Longstocking, was forced to pay more than 100% of her income in taxes. But tax-and-spend did not work: Sweden fell from being the fourth-richest country in the world in 1970 to the 14th in 1993.

Since then the Nordics have changed course—mainly to the right. Government’s share of GDP in Sweden, which has dropped by around 18 percentage points, is lower than France’s and could soon be lower than Britain’s. Taxes have been cut: the corporate rate is 22%, far lower than America’s. The Nordics have focused on balancing the books. While Mr Obama and Congress dither over entitlement reform, Sweden has reformed its pension system (see Free exchange). Its budget deficit is 0.3% of GDP; America’s is 7%.

On public services the Nordics have been similarly pragmatic. So long as public services work, they do not mind who provides them. Denmark and Norway allow private firms to run public hospitals. Sweden has a universal system of school vouchers, with private for-profit schools competing with public schools. Denmark also has vouchers—but ones that you can top up. When it comes to choice, Milton Friedman would be more at home in Stockholm than in Washington, DC.

All Western politicians claim to promote transparency and technology. The Nordics can do so with more justification than most. The performance of all schools and hospitals is measured. Governments are forced to operate in the harsh light of day: Sweden gives everyone access to official records. Politicians are vilified if they get off their bicycles and into official limousines. The home of Skype and Spotify is also a leader in e-government: you can pay your taxes with an SMS message.

This may sound like enhanced Thatcherism, but the Nordics also offer something for the progressive left by proving that it is possible to combine competitive capitalism with a large state: they employ 30% of their workforce in the public sector, compared with an OECD average of 15%. They are stout free-traders who resist the temptation to intervene even to protect iconic companies: Sweden let Saab go bankrupt and Volvo is now owned by China’s Geeley. But they also focus on the long term—most obviously through Norway’s $600 billion sovereign-wealth fund—and they look for ways to temper capitalism’s harsher effects. Denmark, for instance, has a system of “flexicurity” that makes it easier for employers to sack people but provides support and training for the unemployed, and Finland organises venture-capital networks.

The sour part of the smorgasbord

The new Nordic model is not perfect. Public spending as a proportion of GDP in these countries is still higher than this newspaper would like, or indeed than will be sustainable. Their levels of taxation still encourage entrepreneurs to move abroad: London is full of clever young Swedes. Too many people—especially immigrants—live off benefits. The pressures that have forced their governments to cut spending, such as growing global competition, will force more change. The Nordics are bloated compared with Singapore, and they have not focused enough on means-testing benefits.

All the same, ever more countries should look to the Nordics. Western countries will hit the limits of big government, as Sweden did. When Angela Merkel worries that the European Union has 7% of the world’s population but half of its social spending, the Nordics are part of the answer. They also show that EU countries can be genuine economic successes. And as the Asians introduce welfare states they too will look to the Nordics: Norway is a particular focus of the Chinese.

The main lesson to learn from the Nordics is not ideological but practical. The state is popular not because it is big but because it works. A Swede pays tax more willingly than a Californian because he gets decent schools and free health care. The Nordics have pushed far-reaching reforms past unions and business lobbies. The proof is there. You can inject market mechanisms into the welfare state to sharpen its performance. You can put entitlement programmes on sound foundations to avoid beggaring future generations. But you need to be willing to root out corruption and vested interests. And you must be ready to abandon tired orthodoxies of the left and right and forage for good ideas across the political spectrum. The world will be studying the Nordic model for years to come.

"It would be a serious blunder to neglect the fact that inflation [i.e. an increase in the money supply- Tom] also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of imaginary or apparent profits.... If the rise in the prices of stocks and real estate is considered as a gain, the illusion is no less manifest. What make people believe that inflation results in general prosperity are precisely such illusory gains. They feel lucky and become open-handed in spending and enjoying life. They embellish their homes, they build new mansions and patronize the entertainment business. In spending apparent gains, the fanciful result of false reckoning, they are consuming capital. It does not matter who these spenders are. They may be businessmen or stock jobbers. They may be wage earners.... "

"It would be a serious blunder to neglect the fact that inflation [i.e. an increase in the money supply- Tom] also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of imaginary or apparent profits.... If the rise in the prices of stocks and real estate is considered as a gain, the illusion is no less manifest. What make people believe that inflation results in general prosperity are precisely such illusory gains. They feel lucky and become open-handed in spending and enjoying life. They embellish their homes, they build new mansions and patronize the entertainment business. In spending apparent gains, the fanciful result of false reckoning, they are consuming capital. It does not matter who these spenders are. They may be businessmen or stock jobbers. They may be wage earners.... "